Home > Economic policy, Economics - General > Stern on the costs of climate change, Part 1

Stern on the costs of climate change, Part 1

November 17th, 2006

The standard (expected utility) approach to assessing the cost of climate change is to
(i) derive a probability distribution for possible rates of climate change under some given projections,
(ii) attach a cost (or benefit) number to each possible outcome, expressed in utility terms,
(iii) calculate the expected utility gain (or loss)
(iv) express the calculated number as a percentage change in some income aggregate (usually GDP)

In this post, I’m going to look at step (ii). In most respects, the Stern review has adopted assumptions that favour strong action to mitigate climate change – relatively optimistic regarding the costs of stabilising CO2 levels, and relatively pessimistic regarding projections of changes in climate. But the cost calculations are conservative, probably because the previously published estimates of Mendelsohn, Nordhaus and Tol have been way too low.

There are two big problem areas. First, the published estimates assume very low adaptation costs – in fact, a lot of the Mendelsohn-Nordhaus estimates assume that adaptation costs are zero. But adaptation costs are already significant – we need only look at the large sums of money being spent in response to changes in rainfall patterns in south-eastern and south-western Australia. Of course, we can’t tell for sure that these changes are permanent climate shifts rather than bad draws from a stable distribution. But that doesn’t help us – we have to bear the costs now and take the chance that rainfall will return to normal, and our money will turn out to have been wasted. Mendelsohn and Nordhaus have got this issue wrong, and Stern largely follows them.

But the treatment of non-market costs is far worse. Even modest changes in climate will have huge impacts on ecosystems. Stern quotes estimates that a 2 degree change in climate (which is pretty much inevitable) will result in the extinction of between 15 and 40 per cent of all species. The business-as-usual scenarios are far worse Nordhaus and Boyer give trivially low estimates of the cost of such a catastrophe $2.5 billion per year for the United States, and $1 billion for Europe. The latter sum also includes damage to cultural sites such as possible flooding in Venice. The implied cost of ecological disaster is of the order of 0.02 per cent of GDP or about 20 minutes of output per worker per year – a tiny fraction of the time that people spend watching wildlife documentaries, visiting national parks and so on. The number is so absurdly wrong, I find it hard to believe Nordhaus and Boyer gave it any thought at all.

The problem is that this is a field that advocates of inaction have had to themselves. Most economists who have thought about the question have looked at the projections of species extinction, concluded that the costs are easily large enough to justify action, but impossible to quantify. The only people who have produced numbers have been those whose prior beliefs are in the far lower tail.

Stern pushes the non-market cost estimates a bit higher than those of Mendelsohn, Nordhuas and Tol, but they are still way below 1 per cent of GDP for 2 degrees of warming. In my submission to the review, I presented a number of lines of evidence suggesting that people would be willing to pay between 1 and 5 per cent of GDP to prevent large-scale species extinction. Looking again, I think my own numbers have been pulled down by the anchoring effect of the absurdly low starting point that’s been presented in the older literature. Over the course of a century, I’m confident people in developed countries would give up 10 per cent of their (rapidly growing) income or more rather than wipe out most of the species with which we share the planet.

In most respects, Stern has adopted estimates that favour action – relatively low for the costs of stabilisation, and relatively high for the projected rate of climate change under BAU. But the downward bias of the median cost has a bigger impact than the combined effect of these (more widely-discussed) biases going in the opposite direction.

  1. Tam o’Shanter
    November 17th, 2006 at 20:32 | #1

    I will leave the “economics” on this thread to later except to note that Mendelsohn Nordhaus and Tol have been peer reviewed time and again. But for “species extinction at 40% of all species” I hope I may report that Bob May (Lord May late President of the Royal Society to all you peasantry) admitted at UNSW last year that he has no idea how many species there ever have been or how many there are now or how many have gone extinct lately, and this is his area of expertise. Not only that, new species are being discovered on an almost daily basis. So what does JQ know that Bob doesn’t? Moreover I find it odd that devout evolutionists like JQ in this context become creationists oblivious of survival of the fittest. If 40% of an unknown quantity dies out, self-evidently they were unfit.

  2. frankis
    November 17th, 2006 at 22:49 | #2

    They were fit enough until you the mortal God came blundering in to the fray Tambo; would you still call them “unfit” if you were wilfully as opposed to merely negligently wiping them out? Of course not, so your terminology is meaningless (yet indicative of something, after all).

    JQ sets the pace and shows the way, it’s high time economic debate shrugged off the dumb weight of pissant punditry and got down to the hard business of better dealing with reality. No more nonsense about the cost of things from those who don’t appreciate the value of them.

  3. BillyMM
    November 17th, 2006 at 22:55 | #3

    May I know a little bit about the difference between
    the adptation cost and discount pricing facing the
    uncertainty?

  4. conrad
    November 18th, 2006 at 07:51 | #4

    That’s weird logic Tim. Simply because you don’t know something exists doesn’t mean to say it doesn’t matter. I don’t know what 99% of bird species are, but I wouldn’t want to kill them because of my ignorance. In addition, I don’t really get how rapid human caused climate change really has much to do with survival of the fittest. I could use the same argument for all the things that die around a toxic factory, or the same argument justifying all the species that have died because of human carelessness and stupidity (they just weren’t fit enough..). Why not destroy the environment now and just leave the super-fit cockroaches?

    Personally, I think that if we do wipe out 15-40% of all species even though we know we don’t need to, a lot of generations are going to look back at us as selfish money obsessed morons that wern’t willing to make comparitively small comprimises.

  5. Tam o’Shanter
    November 18th, 2006 at 12:17 | #5

    JQ “I’m confident people in developed countries would give up 10 per cent of their (rapidly growing) income or more rather than wipe out most [previous para it was 15-40, now 90+] of the species with which we share the planet.”

    The Business (a UK mag) reports that a leaked draft of the U.N.’s Intergovernmental Panel on Climate Change upcoming Fourth Assessment Report calculates that achieving the goal of limiting greenhouse gases to 550 ppm could cost as much as 5 percent of global GDP [instead of Stern's 1%]. If the IPCC’s calculations are correct, the article notes, “they open up the possibility that the British proposals would cost as much as they save, making them redundant.”

    A fortiori, 10% produces a negative return from Stern’s 5% benefit of GDP “now and forever” from preventing AGW. This way madness lies, certainly not cost benefit analysis as I have taught and practised it.

    Conrad: I am advised by my wife who knows about these things (she’s a renowned archaeologist) that there is in fact no evidence whatsoever that species extinction is happening now at any faster rate than it ever did (check out the fossil record); extinction is indeed part of the evolutionary process. Do not underestimate adaptation – the Dutch have protected themselves from rising sea levels for 500 years and more. Birds are expert at migration, most species are fully capable of migrating north or south as the case may be to wherever it may be a little cooler than where they are if that gets too hot. However bear in mind that the daily range of temperature in much of the non-tropical world is much larger than the IPCC’s doomsday forecast increase in the average temperature of less than 5C, eg in Canberra this week min 0C max 23C; so a change in the average of 5 implies min 2.5 and max 25.5. As Canberra can also manage minus 7 and max 39, 2.5 gains in both min and max are well within the capacity of the lizards and birds etc in my garden to cope with.

    All same, Conrad, you are right, the cockroach will outlast all of us if the Stern/Quiggin approach is adopted.

  6. jquiggin
    November 18th, 2006 at 12:21 | #6

    10-5 > 0

  7. November 18th, 2006 at 15:13 | #7

    Leaving aside the frankly nonsensical arguments of Tam’O'Shanter for the moment (when he can explain where the alpine grasslands of the Great Dividing Range are supposed to toddle off to I might take him seriously) it seems to me that a more important question might be what kind of economic hit, and when, can we expect developing nations to take to reduce their emissions.

  8. Tam o’Shanter
    November 18th, 2006 at 15:35 | #8

    jquiggin Says:
    November 18th, 2006 at 12:21 pm
    10-5 > 0

    Fantastic – but if the cost of saving 90+% of species is 10% of my income, and the benefit from climate change costs avoided is 5%, then if my income is $100 now, and will only be $95 next year because of CC, then my income next year will be only $90 if JQ has his way, or $5 less than it would be even with CC, not >$100 according to JQ’s new math. Incredibly enough, if one has to spell it out again, we are now offered a 100% sure reduction of 10% to ward off a 1% chance of a 5% reduction due to CC. That certainly opens a whole rich seam of new journal articles for JQ.

  9. jquiggin
    November 18th, 2006 at 17:05 | #9

    Umm, you have it back to front, as is so often the case. You’re suggesting a cost figure of 5 per cent, and the 10 per cent you quote is my estimate of willingness-to-pay, that is, benefit. I thought my subtle hint might alert you to this.

  10. November 18th, 2006 at 17:06 | #10

    when he can explain where the alpine grasslands of the Great Dividing Range are supposed to toddle off to I might take him seriously

    Thank you Robert for taking the words out of my mouth. There’s the odd mountaintop cloud forest that might have a few issues also, not to mention coral reefs. Ahhh, but these would be externalities wouldn’t they?

  11. Tam o’Shanter
    November 18th, 2006 at 18:22 | #11

    JQ said: …�You’re suggesting a cost figure of 5 per cent, and the 10 per cent you quote is my estimate of willingness-to-pay, that is, benefit. I thought my subtle hint might alert you to this�.
    Stern’s proposal is that we forego one per cent of our present income in order to avoid a loss of 5% from climate change “now and forever�, for a benefit:cost ratio of 5:1.
    Am I right that your proposal is that we divert 10% of our present income from its present allocations to consumption (SUVs etc) and investment (shares and other super) to saving the planet and 90% of extant species, and that the benefit of so doing is the benefit, which implies a benefit:cost ratio of 1:1.
    I don’t think Gordon Brown would have applauded Stern for such a prospectus. He is already distancing himself from Stern’s manic ravings.
    Robert & carbonsink: reductio ad absurdem is all very well, but as evolutionists surely the idea is that we adapt to the environment, not the environment to us? Your comments are entirely consistent with JQ’s system whereby costs are benefits, and benefits are costs. So then we can all be happy.

  12. Tam o’Shanter
    November 18th, 2006 at 18:24 | #12

    Sorry: benefit of so doing is the benefit, please read “benefit of doing so is the cost”

  13. Hermit
    November 19th, 2006 at 06:43 | #13

    I thought this article http://www.msnbc.msn.com/id/15563663/site/newsweek/from/RSS/ neatly summarises the huge inertia for climate inaction. The author also thinks Stern is too sanguine on net costs but doesn’t quantify the argument. I think it will take several major disasters and changes of world leaders before meaningful steps are taken.

  14. Richard Tol
    November 20th, 2006 at 08:16 | #14

    In the summary of the Stern Review, the benefit-cost ratio is 5-20. (In the report, the range is actually 0.08 to infinity).

    There are many things wrong with Stern. Let’s start with the damages. First, he double-counts risk. He adds the certainty-equivalent of catastrophic loss by Nordhaus and Boyer to the other impacts, treats it as an uncertain parameter, and then computes a certainty-equivalent. Second, he emphasises the negative surprises of climate change, but denies no-surprise-at-all positives, such as reduce winter mortality. Third, he assumes that vulnerability is constant. He has Africans grow rich but die of malaria nonetheless.

    The costs of emission reduction are equally suspect. First, the rising cost of energy has no effect on the economy. Second, capital stock turnover is ignored. Third, the analysis stops at 2050 — although most analyses has costs accelerating after 2050, Stern just ignores that.

    I don’t know about U Queensland, but if a student of mine produces such nonsense, (s)he fails.

    Finally, the benefit-cost ratio is based on an unusually low discount rate.

    Low cost, high benefits, low discount rate: Stern’s benefit-cost ratio of 5-20 is at least an order of magnitude off, but more likely two orders of magnitude.

  15. wilful
    November 20th, 2006 at 09:29 | #15

    …my wife who knows about these things (she’s a renowned archaeologist)…

    Perhaps that explains some of your ignorance. Maybe if she was a palaeontologist she would have some expertise.

    I would suggest having a look at some of the articles (including plenty of published reviewed papers) here regarding the elevated extinction rate: http://www.well.com/user/davidu/extinction.html

  16. jquiggin
    November 20th, 2006 at 17:32 | #16

    “The costs of emission reduction are equally suspect. First, the rising cost of energy has no effect on the economy. Second, capital stock turnover is ignored. Third, the analysis stops at 2050 — although most analyses has costs accelerating after 2050, Stern just ignores that.”

    I can’t follow or don’t agree with these points.
    (i) presumably the rising cost of energy is the mechanism through which the costs of emissions reductions are borne, so what does it mean to say that it has no effect?
    (ii) how so? presumably it’s the need for capital stock turnover that requires a gradual path of emissions reductions – otherwise we could cut emissions immediately
    (iii) I would have said the opposite. Most analyses I’ve seen suggest BAU emissions (and therefore costs of a lower emissions path) will decelerate after 2050 mostly because of the likely development of alternative energy sources. Stern’s procedure effectively treats costs as growing in line with the economy after 2050 which seems like a reasonable compromise in the absence of better information

  17. Tam o’Shanter
    November 20th, 2006 at 17:57 | #17

    wilful: add Paleo-environmentalist. Your link is to non-peer reviewed sources; none of the four attribute the cited extinctions to climate change. The decline in numbers of predators in Africa is largely because the native populations there having failed to develop their own food supply increasingly and pathetically prey on the predators for their own “nyama” (meat). My great leader Robert Mugabe is in the forefront of shooting out all game from Zimbabwe.The cited decline in fish numbers is indeed wretched and entirely due to failure to enforce property rights over the oceans (just as said Bob abolished property rights in Zim including the game farm at Imire, where rhino orphans were being cared for when I stayed there in 1998, until the vets moved in, and in Zim “vets” are not veterinary surgeons). http://www.awionline.org/pubs/Quarterly/winter2001/zimbabwe.htm

    Iceland has by force when necessary (it routed the Royal Navy in the 1970s) secured its property rights over the fish in its 200 mile limit and there the cod – eliminated by the EU in its waters (like all other fish in the ACP sea areas where it was too easy for the EU to bribe presidents to trade fishing rights in exchange for subventions to their Swiss accounts) – still thrive. Alas, all too many of the social democrats on this blog do not believe in property rights except for themselves. Are you any different?

  18. Richard Tol
    November 20th, 2006 at 18:21 | #18

    To John Q:

    (i) Yes, you are right. Stern does it all wrong, though. The 1% of GDP he quotes is the extra cost of energy only, not the economy-wide effect.

    (ii) Yes, you are right. Stern does it all wrong, though. There is no capital stock in the model that he used.

    (iii) Yes, you are right. Stern does it all wrong, though. He simply ignores costs after 2050.

    Maybe you want to read the report by Dennis Anderson from which Stern got his numbers?

  19. jquiggin
    November 21st, 2006 at 20:27 | #19

    I’d be very keen to read this report. Do you have a link, or could you send me a copy?

  20. Richard Tol
    November 21st, 2006 at 20:41 | #20

    Dennis Anderson’s report, the source of Stern’s 1% of GDP to save the planet, can be found at

    http://www.hm-treasury.gov.uk/media/8A3/32/stern_review_supporting_technical_material_dennis_anderson_231006.pdf

  21. November 27th, 2006 at 15:12 | #21

    Most of the assertions in Stern are based on commissioned papers as I discovered a few days ago. I’ve been going through them slowly. For example, Hepburn and Klemperer on discount rates, and Arnell on rapid climate change. Some of them are pretty sketchy, however, Stern did not go off half cocked, or at least not half cocked by himself. It looks like the sort of deal where given a pyramid of choices, he always moved in one direction, or at least found advisors who did it for him. It’s not so much that he cannot justify each choice (tho some are strained), but it was no random walk.

  22. garhane
    December 7th, 2006 at 11:01 | #22

    There is an Indian myth, here on the West Coast of Canada, which says that the Salmon, the Bear and the Forest depend on each other for their survival. A pretty story it is, You read it to the kids so they get some idea of the inter-dependence of life, the web of life alolng the lines of Storer, and so on. Now comes scientific papers described in the Bulletin of the Suzuki Institute that say it is literally true. There is some type of nitrogen that the fish have which the bears transfer to the forest floor as they munch on the salmon and it is critical to the growth of the trees.
    It is tales like that that make this lay reader very uneasy as I note the arrival of the economists to the issues of environment. Here we are wondering how long we get to live on a shrinking ice flo and these guys want to talk about consumer preferences, tastes, and discount rates. Are we really supposed to make social decisions (which is done by a device called politics, I think) on the basis of whose discount rate you like at the moment? I guess I will wait and read for a while. But I think many have a well trimmed fuse when economists start allocating. The audition is likely to be short.

  23. garhane
    December 7th, 2006 at 11:02 | #23

    There is an Indian myth, here on the West Coast of Canada, which says that the Salmon, the Bear and the Forest depend on each other for their survival. A pretty story it is, You read it to the kids so they get some idea of the inter-dependence of life, the web of life along the lines of Storer, and so on. Now comes scientific papers described in the Bulletin of the Suzuki Institute that say it is literally true. There is some type of nitrogen that the fish have which the bears transfer to the forest floor as they munch on the salmon and it is critical to the growth of the trees.
    It is tales like that that make this lay reader very uneasy as I note the arrival of the economists to the issues of environment. Here we are wondering how long we get to live on a shrinking ice flo and these guys want to talk about consumer preferences, tastes, and discount rates. Are we really supposed to make social decisions (which is done by a device called politics, I think) on the basis of whose discount rate you like at the moment? I guess I will wait and read for a while. But I think many have a well trimmed fuse when economists start allocating. The audition is likely to be short.

Comments are closed.