Reviewing the Stern Review, again

Following the publication of this piece in the NY Times, I’ve had a string of email exchanges with Hal Varian, cc:ing Brad DeLong in the role of interested onlooker. I was surprised by the NY Times article since it included both a correct statement of the way in which Stern treats discounting and income redistribution (roughly speaking a 1 per cent change in income has the same value whenever it is incurred and whoever receives it) with a lot of statements that were either misleading or downright wrong, implying that the near-zero rate of pure time preference in the Stern Review implied a near-zero discount rate for cash flows.

Since Varian is one of the brightest and most technically careful people in the economics profession, I was unsurprised by the correct statement, but very surprised to see errors I’d already refuted when put forward by Arnold Kling, Bjorn Lomborg, Megan McArdle and others. Email revealed that the main problems arose from editorial attempts to ‘simplify’ things for readers, but we still have a lot of disagreements about the justifiability or otherwise of inherent discounting.

In any case, all this has spurred me on to produce my long-promised review of Stern on discounting, at least in draft form. Read, enjoy and criticise.

28 thoughts on “Reviewing the Stern Review, again

  1. Mr Quiggan – thank you for your paper on the way the Stern Review discounts future costs and benefits. I gather critics mostly contend that eta is far too low, thereby giving too much weight to the welfare of future generations who are expected to be wealthier than the current generation. They also contend that the discount rate used in the Stern Review is below observable market returns. As I understand it, the observable market returns contended for by critics effectively imply that the current generation have very low regard for the welfare of future generations.

    Is there a way to construct an inter-generational trading mechanism that allows future generations to compensate the current generation for investing in projects that enhance the welfare of the future generations? Could a global carbon emission trading scheme serve as such a mechanism? Each generation would invest in carbon reducing projects to earn carbon credits that have a monetary value which could be realised within the life time of that generation and paid for by each succeeding generation.

    Perhaps a problem with this approach is that a future generation could be tempted to walk away from carbon emission trading – e.g., by issuing more carbon credits that effectively devalue already issued carbon credits. Is there some kind of moral hazard that a future generation will not honour the inter-generational bargain? Or perhaps carbon emission trading could somehow be institutionally entrenched in a way that makes it almost impossible for any future generation to undermine carbon emission trading (no matter how great the temptation to do so).

    If using current market rates to discount future costs and benefits mean that climate change measures are not worth implementing, and assuming this continues to be the case for future generations, does this imply that a carbon emission trading scheme is not sustainable into the future? Perhaps this is what your paper implies, if it is true that the discount rate used in the Stern Review, while ethically defensible, is substantially below the returns required to compensate a generation that has little regard for the welfare of future generations.

    Best regards,

    Kien

  2. KYC your argument reminds me of the ‘forgetting cycle’ whereby the US forgot the lessons of the Vietnam war and repeated them in Iraq. I think there are several reasons why a stabilised climate is unlikely to lead to a relaxation of mitigation efforts. First people have concern for their children and grandchildren, a kind of unquantified discounting. There will still be enough lasting repercussions to keep people angry; for example the need to drink recycled sewage will rekindle fond memories (or archive footage) of the flowing streams of the mid 20th century. There will also be new kinds of natural disasters to keep people vigilant such as the comet ‘Apophys’ in near-earth orbit in 2036.

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