The “ “Stern Review Stern Review” ” & Its Critics & Its Critics The Implications for the Theory & Implications for the Theory & Practice of BCA Practice of BCA Daniel H. Cole R. Bruce Townsend Professor of Law ( Not Economics ) Indiana University School of Law − Indianapolis
Outline of Paper Outline of Paper Summarizes Stern Review and its findings Summarizes Stern Review and its findings Summarizes criticisms of Stern Review Summarizes criticisms of Stern Review Discusses implications for BCA theory and Discusses implications for BCA theory and practice practice
What the Stern Review Does What the Stern Review Does Assesses costs and benefits of climate Assesses costs and benefits of climate change to 2200 (presuming BAU) change to 2200 (presuming BAU) Assesses costs and benefits of GHG Assesses costs and benefits of GHG mitigation/climate stabilization mitigation/climate stabilization Discusses policy options Discusses policy options (All this in only 600 pages! only 600 pages! ) ) (All this in
The Stern Review’ ’s Model s Model The Stern Review PAGE2002 IAM PAGE2002 IAM Designed to assess not only mean expected Designed to assess not only mean expected values of harm but “ “high harm high harm” ” scenarios to scenarios to values of harm but 2200 2200 79 random variables in Monte Carlo analysis 79 random variables in Monte Carlo analysis Including large-scale discontinuities Including large-scale discontinuities Inputs based on IPCC TAR Inputs based on IPCC TAR Assumptions (values for Ramsey equation) Assumptions (values for Ramsey equation) ρ = 0.1% = 0.1%, , η η = 1, = 1, g g = 1.3%, = 1.3%, r r = 1.4% = 1.4% ρ
The Stern Review’ ’s Findings s Findings The Stern Review Cut emissions 25% by 2050 to stabilize Cut emissions 25% by 2050 to stabilize global climate at 500-550 ppm ppm CO CO 2 eq global climate at 500-550 2 eq Cost: 1% of global annual GDP ( Cost: 1% of global annual GDP ( ≈ ≈ $1 $1 trillion/year) “ trillion/year) “forever forever” ” Benefits (costs of climate change avoided): Benefits (costs of climate change avoided): 5% of global GDP “ “forever forever” ” 5% of global GDP Recommended policies: Increase price of Recommended policies: Increase price of carbon by taxes or tradable quotas carbon by taxes or tradable quotas
Controversial Aspects of Stern Review Controversial Aspects of Stern Review (1) Damage estimates greatly exceed those (1) Damage estimates greatly exceed those of other BCAs BCAs of other E.g., E.g., Nordhaus Nordhaus & Boyer (2000); & Boyer (2000); Mendelsohn Mendelsohn et al. (1998); Tol et al. (1998); Tol (2002) (2002) (2) Recommends earlier and more extreme (2) Recommends earlier and more extreme cuts in GHG emissions cuts in GHG emissions (3) Underlying (1) and (2): exceptionally low (3) Underlying (1) and (2): exceptionally low discount rate discount rate
Critiques of the Stern Review Critiques of the Stern Review The Critics The Critics Nordhaus Nordhaus, , Tol Tol, , Yohe Yohe, , Mendelsohn Mendelsohn, , Dasgupta Dasgupta and Weitzman and Weitzman The Critiques The Critiques problems in damage estimates problems in damage estimates ρ ρ = 0.1% is too low = 0.1% is too low η η = 1 is too low = 1 is too low r r = 1.4% is too low = 1.4% is too low What about the What about the g g ? ?
Problems with Stern’ ’s Damage Estimates s Damage Estimates Problems with Stern 3 standard deviations higher than earlier 3 standard deviations higher than earlier estimates (Yohe Yohe & & Tol Tol 2007) 2007) estimates ( Assume pessimistic scenarios (Yohe Yohe & & Tol Tol 2007) 2007) Assume pessimistic scenarios ( Do not take adaptation into account (Mendelsohn Mendelsohn Do not take adaptation into account ( 2007) 2007) Assume large nonmarket nonmarket damages ( damages (Mendelsohn Mendelsohn Assume large 2007) 2007) Do not specify valuations of human life and other Do not specify valuations of human life and other nonmarket effects effects nonmarket No sensitivity analysis No sensitivity analysis
Is ρ ρ = 0.1% Too Low? = 0.1% Too Low? Is Yes (Nordhaus Nordhaus 2006; 2006; Yohe Yohe & & Tol Tol 2007) 2007) Yes ( Much lower than any other climate change BCA (but see Much lower than any other climate change BCA (but see Cline 1992) Cline 1992) People observed to use must higher rate (Weitzman 2007) People observed to use must higher rate (Weitzman 2007) Explains Stern Explains Stern’ ’s higher damage estimates s higher damage estimates At ρ ρ = = 3% Stern 3% Stern’ ’s damage estimate reduced by 80-90% s damage estimate reduced by 80-90% At No No Discounting is generally unethical (Stern 2006; Ramsey Discounting is generally unethical (Stern 2006; Ramsey 1928) 1928) Climate change is special case Climate change is special case Potential for reductions in consumption (Dasgupta Dasgupta 2006; 2006; Potential for reductions in consumption ( 1999) 1999) Like foreign aid (Schelling 2006) Like foreign aid (Schelling 2006)
Is η η = = 1 Too Low? 1 Too Low? Is Yes (Dasgupta Dasgupta 2006) 2006) Yes ( Even after adjusting for risk, later generations Even after adjusting for risk, later generations will be much wealthier than current generation will be much wealthier than current generation η η = 1 implies ridiculously high savings rate = 1 implies ridiculously high savings rate (97.5%, assuming 4% rate of return on risk-free (97.5%, assuming 4% rate of return on risk-free investments) investments) No (Quiggin Quiggin 2006) 2006) No ( Dasgupta Dasgupta’ ’s s assumed rate of return on risk-free assumed rate of return on risk-free investments is unreasonably high; 1-2% investments is unreasonably high; 1-2% observed in practice observed in practice
It’ ’s the s the r, r, smarties smarties! ( ! ( Weitzman 2007) Weitzman 2007) It It is the combination of ρ ρ , , η η , , and and g g that matters for that matters for It is the combination of the Ramsey equation the Ramsey equation If If ρ ρ = 2%, = 2%, η η = 2, and = 2, and g g = 2%, then = 2%, then r r = 6% = 6% If If ρ ρ = 0%, = 0%, η η = 3, and = 3, and g g = 2%, then = 2%, then r r = 6% = 6% Stern Review’ ’s low s low r r is problematic is problematic Stern Review “ “[ [S]trongly S]trongly against mainstream economics against mainstream economics” ” Ignores how people are observed to behave Ignores how people are observed to behave Paternalistic: imposes analyst Paternalistic: imposes analyst’ ’s own values s own values Stern’ ’s s r r may end up being may end up being “ “more right than wrong more right than wrong” ” Stern Uncertainty over Uncertainty over r r is the is the “ “most important uncertainty in the most important uncertainty in the economics of climate change” ” economics of climate change Long-run uncertainty could reduce value of r Long-run uncertainty could reduce value of r from from ≈ ≈ 6% to 6% to ≈ ≈ 2% 2% (close to Stern figure) (close to Stern figure)
Or, Is It the g g ? (Weitzman 2007) ? (Weitzman 2007) Or, Is It the Climate change damages may not correlate well Climate change damages may not correlate well with aggregate economic activity with aggregate economic activity Low probability, high temperature increases could Low probability, high temperature increases could lead to “ “low-g low-g” ” disasters disasters lead to Knightian Knightian uncertainty: we don uncertainty: we don’ ’t know how much we don t know how much we don’ ’t t know about “ “tail probabilities tail probabilities” ” know about Weitzman recommends combining gradualism of Weitzman recommends combining gradualism of Nordhaus with more study of the with more study of the “ “low-g low-g” ” events on events on Nordhaus which predominate Stern’ ’s (2006) analysis s (2006) analysis which predominate Stern
Implications for Practice Implications for Practice Special problems for BCAs BCAs at the frontiers of at the frontiers of Special problems for scientific knowledge and economic understanding scientific knowledge and economic understanding The political nature of BCAs BCAs and the importance and the importance The political nature of of sensitivity analyses of sensitivity analyses The eternal issue: discounting The eternal issue: discounting Issues in Damage Estimation Issues in Damage Estimation The importance of transparent The importance of transparent nonmarket nonmarket (including (including human life) valuations human life) valuations Taking seriously expected damages beyond the mean Taking seriously expected damages beyond the mean BCA as a dynamic, interative interative process process BCA as a dynamic,
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