Reviewing the Stern Review

The Productivity Commission has just released a paper called The Stern Review: an assessment of its methodology (the full paper is a 1.3Mb PDF). It’s very good, I think, giving a balanced presentation to the Review, its supporters and critics and those who fit into neither category. Here’s the summary:

The Productivity Commission today released a staff working paper titled The Stern Review: an assessment of its methodology. This technical paper contains a detailed examination of key elements of the Review’s analytical approach. Originally prepared as an internal research memorandum following release of the Stern Review’s report, the paper is being made more widely available given its ongoing relevance in light of Australia’s Garnaut Review.

The staff paper finds that the Stern Review made some important analytical advances. The Review sought to move beyond analysis based on the mean expected outcome to one that incorporates low probability, but potentially catastrophic, events at the tail of probability distributions. The Review also attempted a more comprehensive coverage of damage costs than most previous studies.

The paper also finds that value judgements and ethical perspectives in key parts of the Stern Review’s analysis led to estimates of future economic damages being substantially higher, and abatement costs lower, than most previous studies. The paper notes that the report could usefully have included more sensitivity analysis to highlight to decisionmakers the consequences of alternative assumptions or judgements.

Looking at the way debate has evolved both within and outside the economics profession, a few points have emerged

* No-one credible now disputes the view that a well-designed set of policies could greatly reduce CO2 emissions at very low cost. The Stern Review is marginally lower than average at 1 per cent of GDP, but it would be hard to find any serious analyst claiming costs much higher than 3 per cent. These are once off changes in levels corresponding to a once-off loss of between a few months and one year of improvements in material living standards. It’s intuitively hard to see how risking the worst case outcomes of climate change to avoid such a small economic cost could possibly be justified.

* While there is still plenty of dispute about the economic costs of doing nothing, relative to stabilisation, the median estimate has been revised sharply upwards following the Stern Review. On the issue of discount rates, the (still controversial) choice of a low rate by the Stern Review pointed up the dependence of earlier estimates on rates that now look implausibly high. And on the treatment of risk and damage to the natural environment, Stern’s look at these issues points up how badly neglected they were in the past. If anything, subsequent discussion has suggested that Stern was too conservative.

The speed with which the economic debate has evolved has left the political advocates of doing little or nothing stranded. Most of them had no qualifications in climate science, and embraced delusionist arguments against the science because they were opposed on political, economic or culture-war grounds to the kinds of policies needed to stabilise climate. Many of them clearly envisaged a campaign in which they would fight as long as possible on the science before turning to the economics. But the speed of change has left them flatfooted. Rather than being able to make a graceful retreat to a prepared position, they are trying to argue against what is now the mainstream economics position, while still being lumbered with their now-discredited attacks on mainstream science.

87 thoughts on “Reviewing the Stern Review

  1. “The choice between emissions trading and a carbon tax essentially boils down to whether you want to set a firm target for emissions and let the price fluctuate or you want a fixed price and are prepared to let emissions fluctuate.”

    Ian, fluctate has two very different meanings here. A carbon tax is a one way price bet. Upwards and that means demand falls. OTOH cap and trade has fluctuated alright, with little or no overall reduction in overall demand, simply because the resultant price of emission caps fluctuated downwards. Basically they collapsed. Now the scientists can tell us what level of reduction we need to achieve but they are impotent as to how to get there and how quickly. Cap and trade has failed to date and now we’re told all we need is a surge. The reason it has failed so far is that at a theoretical level, you need to either cap emissions at the point of extraction of the fossil fuels(the simplest approach), or cap it at the consumer level, which is nigh on administratively impossible. That’s akin to everyone being issued with a carbon credit card cap and using it up as they consume, presumably with every good or service they buy having a CO2E price tag attached to it. Failing that impossibility, the fallback is to cap the few big industrial users, who have an incentive to game the system exactly as they have done. Now supposing successful caps could be applied logically and administratively simply at the point of extraction, there is the problem of not knowing what price increase would ultimately be thrown up to produce the desired end target. Not so with carbon taxing. The maximum theoretical price would be the total tax take needed to produce the current level of govt expenditure(well short of running huge surpluses) Now that’s a lot of readies in anyone’s book, yet that value of tax is theoretically and ultimately available to the owners of those caps over time. Who knows what economic rent they’ll ultimately be able to extract from them? They certainly don’t or anyone else, which is the great unknown information problem for auctioning caps. Our ancestors may be gobsmacked at what water(land) rights to the MD basin are worth nowadays, when they were carving up their bottomless river all those years ago. try buying some environmental flows nowadays and see what we’re up for. That’s the legacy we could leave our grandkids with cap and trade.

    You missed the obvious third option, which could develop over time as a mix of the two appraoches. Basically we emit C tonnes now and want to get to say 0.4 x C tonnes in thirty years. the govt issues C tonnes of licences right away, reducing by 2% per year for the next thirty years and cahrges an annual licence fee for same. They can be traded openly, provided the annual ongoing licence fee is paid. If not paid by the due date, the permit is cancelled and reissued on the open market under the same terms. Like a drivers licence but not tied to the original licensee and like purchasing a drivers licence the fee could rise over time. That’s the only ‘fluctuation’ as you call it, I’d like to see. That could allow most of the economic rent to be captured communally and the scientists’ hallowed targets met, without the large informational uncertainty involved in buying those caps today.

  2. Ian, of the three points you list above about the ultra-battery, only #3 is really a point in its favor.

    You say: “Firstly, as I’m sure you realise, while black coal is the largest component of the Australian fuel mix its not the only one.

    There’s an argument to be made here that if there was a lot more wind generators connected to the system, then battery storage for cars would make good use of off-peak wind power. There was a CSIRO paper to this effect (last year? year before?) but I think he was talking about using home-installed roof top wind, could be wrong about that, can’t find the paper at the moment. I’ll dig it up later if I can. But as things stand, and as I’ve already said, when we’re talking about off-peak power, coal is the only game in town. The only other sources that generate during off-peak are those that are uncontrollable, like wind and run-of-river (i.e. non-storage) hydro. There’s bugger all of those things at the moment. Other things like wave and tidal power might add to this in the future, but at the moment they aren’t there. So the ultra-battery may be useful at some point in the future, but the use of the thing right now as an off-peak charged device would only make things worse.

    You Say:Secondly, the average emissions per kilowatt hour include the overnight emissions from power plants operating at minimum load – which is highly inefficient. Plug-in hybrids would effectively deliver a big chunk of load-levelling allowing those plants to be used more effectively.

    The average emmission figure represents a “best case”. Increasing the off-peak load on the power plants to bring the emmissions up to average does not give a greenhouse saving when the alternative, i.e. running the hybrid on petrol, would save one third more greenhouse emissions.

    carbonsink, I don’t know what your position is, and I don’t much care. Facts added into a discussion usually help, regardless of the units that they’re given in. I gave references and derivations for my 0.2 kg/mile figure, which is equivalent to 0.12 kg/km. Your statement “FYI: a Prius is officially rated at 104g/km.”, I see as pointless handwaving. It’s not supported by any references, and even if it was, would not change the conclusions I drew. You even acknowledge that you agree with my conclusions. Grow up, sport. Not everyone on the internets has a personal vendetta against you.

  3. The italics didn’t work out properly above. The third paragraph should start like this:

    There’s an argument to be made here that if there was a lot more wind…

  4. “Well yes, the families with combined incomes below $100K, McMansion mortgaged to the hilt, credit cards maxed out, and a pair of 4WDs in the garage.

    Are you saying these people don’t exist?”

    I’m saying if you want to see lower income people next time you’re in Brisbane I’ll take you around Inala and Logan Central – or Greenslopes or Wynnum or Redcliffe . In all cases you’ll note the absence of both SUVs and McMansions.

    A combined family income of $100 K is pretty much smack on the median and certainly doesn’t make you lower income.

    Try a combined family income of $40K.

  5. “OTOH cap and trade has fluctuated alright, with little or no overall reduction in overall demand, simply because the resultant price of emission caps fluctuated downwards. Basically they collapsed.”

    Yes, the price of permits which were given away for free and which were going to expire in around six months with no penalties for emissions in excess of the permits a company held collapsed.

    Your point?

    The Europeans only started imposing penalties on companies for not having permits this calendar year – and the penalties won’t actually be imposed until next year.

    Basically, European emission trading prior to 1 January 2008 was a dry run with no practical impact – and everyone knew it.

    “Cap and trade has failed to date…”

    No, cap and trade has been used successfully for a decade or more to control pollutants other than carbon dioxide.

    “You missed the obvious third option, which could develop over time as a mix of the two appraoches. ”

    Actually no I didn’t you’ll notice I specifically said the two approaches could be combined.

  6. I’m saying if you want to see lower income people next time you’re in Brisbane I’ll take you around Inala and Logan Central – or Greenslopes or Wynnum or Redcliffe. In all cases you’ll note the absence of both SUVs and McMansions.

    Well if these people already use public transport and they don’t have huge McMansions to heat and cool then they will be less impacted by rising energy prices. If your primary concern is for low income earners, why not use the proceeds from a carbon tax to raise the tax free threshold to $40,000?

    The people I am talking about are the people formerly-known-as-the-Howard-battlers, the aspirationals, the mortgage belt … whatever you want to call them. They are going to be hit hard by any kind of price on carbon, and if we’re going to solve this problem they have to be. They need to get the message that their lifestyles are unsustainable.

    Problem is, these are the very same people that sit in the middle of the political spectrum and determine the outcome of most elections. It will take a politician of extraordinary courage to punish these people with higher petrol and electricity prices.

    Grow up, sport. Not everyone on the internets has a personal vendetta against you.

    Charming.

  7. “Yes, the price of permits which were given away for free and which were going to expire in around six months with no penalties for emissions in excess of the permits a company held collapsed.
    Your point?”
    My point is that while they’ve all been dicking about with fluctuating prices and trying to work out how on earth cap and trade is really going to work, a level playing field carbon tax would have still been up there impacting on demand and sending signals to the market to find alternatives. However like the good burghers of Quebec, cap and traders are really interested in trying to pull the wool over everyone’s eyes and buck pass price increases to big biz, pretending its not really a tax, all the while passing the defacto taxing power to big biz, because an upfront auction of caps (bearing in mind the impossible information problem)would give their sly game away immediately. Exactly as Quebecans found out quick smart with their ‘green fund’ being passed on.

  8. The other problem cap and trade will create in the marketplace, is exactly what the ACCC is banging on about with their whinge about a petrol pricing oligopoly and those 4 major oilcos currently Ian. Basically they want to see more importers(ie suppliers) of petrol from different sources. That’s a problem now, given the large investment in infrastructure any new player has to find to take a risk on. How much bigger hurdle will that be with blue sky emission caps added on? As for me I’ll be watching to see which companies scoop up the cheap upfront caps and betting on them long term on the stockmarket. The poor slobs can suit themselves.

  9. In defence of cap and trade it is target driven whereas carbon taxation could miss or overshoot. Thus if the cap is a 10% reduction but recession causes a 15% emissions drop the cap is no longer binding. Conversely carbon tax relief might be called for. As far as dodgy offsets (most of them probably) are concerned I’m sure Big Coal would want deductions from carbon taxes eg BlueScope Steel’s request for brownie points for heat recycling. Auctioning of permits could reduce grandfathering and create revenues for cleantech R&D grants.

    That’s all theory. I’m leaning more and more towards recession and skyrocketing energy prices making the cuts that politicians can’t.

  10. That’s all theory. I’m leaning more and more towards recession and skyrocketing energy prices making the cuts that politicians can’t.

    Lets face it, the politicians aren’t going to do anything that hurts their constituency, the market (and more specifically the oil market) will do that for them.

    The best we can expect from our pollies is a lot of hand wringing about petrol prices, perhaps another enquiry into petrol pricing, and if they really start to hurt in the polls, a cut in the fuel excise.

    It makes you wonder whether democracy can solve this problem.

  11. I have had a bit of a read of Chapter 5 of the Productivity Commission’s working paper. This chapter is on aggregating costs and benefits and discusses discount rates and cost benefit analysis. The working paper has a good discussion of the limits of cost-benefit analysis. There was an important issue to do with cost-benefit analysis that the paper failed to mention. This is related to a preprint by Martin Weitzman that now is titled “On Modeling and Interpreting the Economics of Catastrophic Climate Change” http://www.economics.harvard.edu/faculty/weitzman/files/modeling.pdf

    The latest preprint is dated January 14 so the productivity commission can’t really be blamed for not discussing it. Weitzman’s paper argues that: “(1) because of deep structural uncertainty about the prospects for disastrously large temperature changes, there is a strong prima facie case that the relevant probability density function (PDF) of climate change catastrophes has an extreme tail that is heavy with probability; (2) when these heavy tails are combined with very unsure high-temperature damages, this aspect can dominate the discounting aspect in calculations of expected present discounted utility (even at empirically plausible real-world interest rates); (3) all of this translates into placing severe limitations on the reliability of policy advice coming from standard cost-benefit analysis (CBA) of climate change; (4) the conventional climate-change policy ramp is an extreme lower bound on what is reasonable rather than a best estimate of what is reasonable; (5) removing the artificial limitations on conventional CBAs that comes from excluding very-high-impact disasters is capable of shifting a more inclusive economic-welfare analysis strongly away from the gradualism of a climate-change policy ramp.”

    Parameters such as climate sensitivity have “fat tails”. Climate sensitivity is the expected increase in temperature that would arise from a doubling of greenhouse gasses. There is a small chance (something like 1%) that the climate sensitivity will be something like 10-20 degrees, which would potentially catastrophic consequences. Weitzman’s paper discusses what a “rational economic response” to these issues is and argues that “structural or deep uncertainty is potentially much more of a driving force than discounting or pure risk for cost-benefit applications of EU theory to open-ended situations with potentially unlimited exposure”.

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