"WHAT IS WRONG WITH STERN?"

- Tuesday, 4th September 2012

 

Papers

WHAT IS WRONG WITH STERN?

The Failings of the Stern Review of the Economics of Climate Change

Peter Lilley MP

Foreword by Professor Richard Tol

The Global Warming Policy Foundation

GWPF Report 9

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GWPF REPORTS

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What Is Wrong With Stern?

What Is Wrong With Stern?

The Failings of the Stern Review of the Economics of Climate Change

Peter Lilley MP

Foreword by Professor Richard Tol

ISBN: 978-0-9566875-9-3

© Copyright 2012

The Global Warming Policy Foundation

Contents

Table of Contents 2

About the Author 2

Foreword 3

Introduction 5

Executive Summary 8

Chapter 1 - Background to Stern Review and its Reception 16

Chapter 2 - Key Criticisms of the Stern Review’s Conclusions 18

Chapter 3 - Estimating the Impact of Global Warming 25

Chapter 4 - Costs of Restricting Emissions 37

Chapter 5 - Discount Rate 46

Annex to Chapter 5 : The Ramsey Equation 56

Chapter 6 - Treatment of Uncertainty and Risks 59

Annex to Chapter 6 - Is Stern "Right for the Wrong Reasons"? 66

Chapter 7 - Implications of Stern Review for Developing Countries 79

Chapter 8 - Policy Implications 84

Recommendations 92

Author’s Acknowledgements 94

About the Author

The Rt Hon Peter Lilley MP

Peter Lilley graduated in Natural Sciences followed by Economics at Clare College, Cambridge. He worked as a development economist on aid projects for a number of years before becoming an investment analyst overseas, specialising in the energy industries. Elected to Parliament in 1983 he served as a minister between 1987 and 1997, initially as Economic Secretary, then Financial Secretary to the Treasury before joining the Cabinet as Secretary of State for Trade and Industry, then Social Security. He chaired the Global Poverty Policy Commission set up by David Cameron. He is currently Member of Parliament for Hitchin and Harpenden and Co-Chair of the All Party Parliamentary Group for Trade Out of Poverty.

Professor Richard Tol

Richard Tol is a Professor at the Department of Economics, University of Sussex and the Professor of the Economics of Climate Change, Institute for Environmental Studies and Department of Spatial Economics, Vrije Universiteit, Amsterdam. He received a Ph.D. in economics (1997) from the Vrije Universiteit. He published 194 articles in learned journals, 3 books, 5 major reports and 37 book chapters, He specialises in the economics of energy, environment, and climate. He is an author (contributing, lead, principal and convening) of Working Groups I, II and III of the IPCC.

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Foreword

The publication of the Stern Review of the Economics of Climate Change was a PR exercise that was unprecedented in economics. Sir Nicholas, now Lord Stern, was portrayed as an expert even though he had never published before on the economics of energy, environment or climate. Nick Stern was presented as independent, although he was a senior Treasury official and had been a civil servant, first with international organisations, and latterly in the UK, for 12 years and was supported by a team of civil servants. The Stern Review was claimed to be the first ever economic analysis of and justification for climate policy, although similar studies had been published since the 1980s.

Five years after its publication, many people still seem to believe the myths that surround the Stern Review. Indeed, the Stern Review is regularly cited as a Higher Authority on all matters green and good, including on subjects not covered by the Stern Review.

In this report, Peter Lilley MP revisits the Stern Review and the economic case for climate policy. He shows that there are many errors, big and small, in the Stern Review. At first sight, that is what one would expect from a report on a complex subject written in a short time by a group of novices. However, Lilley also reveals that the errors are systematic and suggestive of an ideological bias.

Policy advice always mixes the normative and the positive. Policy analysis answers the question what if we do nothing or intervene in a particular way. But policy analysis is incomplete without addressing the so what and what to do questions. And there as well, the Stern Review adopted a position that is peculiar.

This is best illustrated with the discount rate. The discount rate has been debated by scholars since Socrates (and perhaps before that). Some of the brightest people in history have investigated the discount rate. The conclusion of all that effort is disagreement: Many positions are defensible, and any position is debatable. Honest policy analysts show results for a range of alternative discount rates. The Stern Review uses a single discount rate. It corresponds to an extreme position in the literature and it deviates from the official discount rate of HM Treasury. Nick Stern is, of course, free to use whatever discount rate he wants in his private life. Professor Sir Partha Dasgupta of Cambridge University has found that Stern should save 97.5% of his income, were Stern to follow the advice in the Stern Review. Taking such an extreme position in public policy is odd.

The problems of the Stern Review could have been avoided if the report had been reviewed, pre-publication, by experts in the field. That was not done because of a fear that Stern’s peers would leak to the media; in fact, the media leaked the Stern Review to academics. It was reviewed post-publication, What Is Wrong With Stern? 4

and no expert in the economics of climate change has stepped forward to defend the assumptions and methods of the Stern Review. Most of the critique came from outside the UK, with most British economists keeping a studious silence, a wise move given the amount of research money since showered on Nick Stern. The more innovative parts of the Stern Review – the non-Newtonian calculus in Chapter 13, for instance – have yet to be submitted to learned journals. Nick Stern has withdrawn from all academic debate.

None of this detracts from the fact that there is an economic case for greenhouse gas emission reduction. We cannot be certain that greenhouse gas emissions do not cause climate change. We cannot be certain that climate change is harmless. In fact, most evidence points in the opposite direction. Although economic analyses have yet to reach any robust conclusion for climate policy in the medium- to long-term, the recommendations for the short-term are widely shared among economists: We should start with emission reduction now, while simultaneously developing the institutions and technologies in case we would need deeper emission cuts later.

Overly ambitious emission reduction in the short run, as embraced by the European Union and the United Kingdom, is needlessly expensive. It is also divisive, particularly when based on flawed analysis like that in the Stern Review. It will take a century to solve the climate problem. Most economic studies conclude that it is best to start with modest emission reduction, and accelerate the stringency of climate policy over time. For that, public policy will need to pull into the same direction over 20 or more electoral cycles. If the case for climate policy is exaggerated, the backlash will come, sooner or later. The Stern Review was a tactical masterstroke, but it will likely prove to be a strategic blunder. Its academic value is zero.

Professor Dr Richard S.J. Tol MEA

University of Sussex

Vrije Universiteit Amsterdam5 What Is Wrong With Stern?

Introduction

Government plans to combat man-made global warming are perhaps the most costly programme since the introduction of the Welfare State – over £17,000 per household.1 Yet, despite widespread academic criticism they have not received the scrutiny they merit from Parliament, media or public.

Ministers still rely almost entirely on the Stern Review of the Economics of Climate Change to justify their policies. Yet Stern’s estimates of the costs and benefits of preventing global warming differ markedly from the consensus among environmental economists and even from the economic assessment of the UN Inter-governmental Panel on Climate Change (IPCC) on whose scientific projections they were based. Whereas Stern said the benefits of reducing emissions would be 5 to 20 times the cost, the IPCC shortly afterwards concluded:

"analyses of the cost and benefits of mitigation indicate

that these are broadly comparable in magnitude"

so it could not establish

"an emissions pathway or stabilization level where benefits exceed costs."

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Ministers constantly urge the public to accept the IPCC’s assessment of the science of global warming because it has the support of most scientists, yet they ignore the IPCC’s economic conclusions which are supported by most environmental economists.

The Review’s message was crisp and dogmatic: immediate action is required to avoid catastrophe; carbon dioxide emissions must be almost eliminated by 2050 to prevent greenhouse gas concentrations exceeding 550ppm; any lower target is unobtainable; any higher target disastrous; we must ration carbon emissions by issuing tradable quotas, backed up by a battery of regulations, subsidies and taxes, the cost of which (it claims) will be astonishingly modest.

Given the public mood when it was published the Stern Review was adopted as Gospel truth; by politicians – because it endorsed an apparently vote winning message; by the media – because the global warming story sold newspapers; and by environmentalists - because it validated their agenda.

Because there was no debate few ministers, MPs or journalists realise that there are alternative strategies involving different timescales, targets, economic instruments and trade-offs between prevention and adaptation.

1 The revised Impact Assessment for the Climate Change Act 2008 estimated the present value of the cost of this Act at up to £430 billion. This excludes transitional costs which it says could be 1.3-2% of GDP up to 2020, and the cost of driving industry abroad, which it says could be significant. There are some 25 million households in the UK.

2 IPCC, Climate Change 2007: Mitigation of Climate Change (Working Group III Contribution to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change). Cambridge, UK: Cambridge University Press, 2007, p. 18.6

Nor are they aware that, on Stern’s calculations, the sacrifices this generation is asked to make to prevent global warming will accrue centuries ahead when people will be many times richer than us and far better equipped to adapt to, prevent or even reverse global warming. Moreover, the worst threat - of melting icecaps raising sea levels dramatically – would, according to the IPCC, take millennia to arrive - even if temperatures rise substantially.

Why return to the economics of climate change now? Recently the public mood has changed. Austerity makes people hard-headed. The costs of cutting emissions have begun to hit households and companies. Global warming seems to have paused in recent years. The ‘Climategate’ emails and IPCC scandals dented public confidence in scientists’ predictions that warming will resume. Political parties committed to costly climate policies in Canada and Australia have faced setbacks; Obama’s Cap and Trade Bill sank without trace, the Copenhagen conference broke up without agreement and subsequent conferences achieved even less. Meanwhile there is growing awareness that the the UK’s contribution to world emisisons is tiny - barely 2% of the total and less than the increase in China’s emissions in a single year. And China has no intention of signing up to a binding commitment to cut its emissions.

Economic difficulties are no reason to question the science of global warming and this study does not do so. Virtually all climate scientists – from sceptics to alarmists – accept that increasing concentrations of greenhouse gases will raise temperatures, other things being equal. The only scientific disputes are about how much, how certain and whether other things are equal. However, economic pressures do justify questioning whether the economics of climate change policy is sound.

In order to focus exclusively on the economics, this paper - like the Stern Review - takes the IPCC’s assessment of the science as given. This does not mean that Stern’s treatment of the science is acceptable. That has been powerfully challenged in a critique3 whose authors foresaw that:

"the Stern Review appears as a misdirected exercise. By taking as given hypotheses that remain uncertain, assertions that are debatable or mistaken, and processes of inquiry that are at fault, the Review has put itself on a path that can lead to no useful conclusion".4

Stern’s selective emphasis on alarmist interpretations and downplaying of uncertainties exacerbates a tendency of the IPCC which the Council of National Science Academies has criticised:

"for emphasising the negative impacts of climate change … the authors reported high confidence in some

3 The Stern Review: A Dual Critique: The Science Robert M. Carter, C. R. de Freitas, Indur M. Goklany, David Holland & Richard S. Lindzen: Economic Aspects Ian Byatt, Ian Castles, Indur M. Goklany, David Henderson, Nigel Lawson, Ross McKitrick, Julian Morris, Alan Peacock, Colin Robinson & Robert Skidelsky. World Economics Oct-Dec 2006.

4 Byatt et al. 2006. The Stern Review "Oxonia" Papers: A Critique (World Economics, Vol. 7, No 2).7 What Is Wrong With Stern?

statements for which there is little evidence".5

This study simply challenges Stern’s economic methods and conclusions – and shows his Review was an exercise not in evidence-based policy making but in policy-based evidence making.

5 Climate change assessments: Review of the processes and procedures of the IPCC. InterAcademy Council October 2010 pxv.8

Executive Summary

Time to review the Stern Review

The government relies on the Stern Review to justify its policies to combat global warming – possibly the most costly programme since the welfare state. But the Stern Review was not fit for purpose.

The Review’s conclusions were way outside the consensus of economic studies it supposedly reviewed and have been roundly criticised by many leading economists. Indeed, Stern’s conclusions, that the costs of a crash programme to reduce emissions are far outweighed by the benefits, contradict even the Intergovernmental Panel on Climate Change (IPCC) which said: "costs and benefits are broadly comparable in magnitude" so it could not establish "an emissions pathway or stabilisation level where benefits exceed costs".

These criticisms were ignored when Stern’s report was published since political parties, media and environmentalists welcomed its conclusions as incontrovertible truth. However, the mood has changed since the recession, as the costs of climate subsidies hit homes and businesses and the Climategate emails provoke scepticism. It is time to look anew at the economics of tackling climate change (while taking as given the IPCC’s assessment of the science – in order to focus exclusively on the economics of climate change policy).

Key conclusions misleading and not comparable

Stern’s headline conclusions were that:

"If we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year now and forever."6

whereas

"The costs of action – reducing greenhouse gas emissions to avoid the worst impacts of climate change – can be limited to around 1% of GDP each year."7

They succeeded in giving the clear impression that we face huge losses now which could be averted at a fifth of their cost. But this is achieved by verbal virtuosity combined with statistical sleight of hand. In fact, even on Stern’s figures, the cumulative costs of reducing greenhouse gases will exceed the

6 Stern Review page xv (NB all footnotes about the Stern Review refer to the printed version)

7 Ibid9 What Is Wrong With Stern?

cumulative benefits until beyond 2100. Stern’s misleading headlines rely on comparing apples and pears as well as conflating predictions centuries hence with the present.

Comparing apples and pears
– or the whole of an apple with part of a pear. Stern compares the cost of limiting the amount of global warming with the benefit of eliminating it entirely. 8 The benefit of preventing it entirely would, on his figures, be at least 5% of GDP – but to do so would require not just stopping all further carbon emissions but removing all those accumulated since the industrial revolution. The action he proposes to reduce the worst impacts of global warming by stabilising the atmospheric concentration of greenhouse gases at 550ppm would, using Stern’s methodology, save some 3.1% of GDP – not 5%. The Review headlines put the cost of meeting his emissions target at 1% of GDP, though Stern has since doubled that and, in the body of his report, the cost was put at up to 4% of GDP. 9

The larger the damage which will still occur if emissions are stabilised at Stern’s target, the more misleading the comparison Stern makes between

the cost of reducing damage and the benefits of eliminating emissions entirely. The smaller the residual climate change damage if emissions are stabilised at 550 parts per million (ppm), the less compelling the case for stabilising at that level.

Describing future centuries as "now".
Stern suggests losses from global warming will be at least 5% of GDP "each year now and forever". 10 This is simply untrue. The cost of his crash programme to reduce emissions does indeed start now and in the decades to come. But the impact of global warming which he wants to mitigate will be largely in the very distant future. Even on Stern’s questionable calculations, it will be the next century before the cumulative benefits of (entirely) preventing global warming would exceed Stern’s low estimate of the costs of (partially) limiting it. 11 Stern justifies his claim by saying losses from global warming centuries ahead are statistically "equivalent to" losses "now and forever". He calculates the "now and forever" figure by taking high losses reached centuries ahead and projected to infinity, then discounting and averaging them with the negligible losses for many decades to come.

Hidden economic assumptions.
Since Stern projects the impact of global warming to infinity, the rate at which he discounts them to the present is crucial. Stern rejects discount rates normally used to compare future costs and benefits – including the rates specified by the Treasury Economic Service which he headed. Instead he adopts an ultra-low rate without explicitly disclosing it in his 700-page report. His low discount rate

8 The comparison first appears in the opening paragraphs of the Summary of Conclusions, page xv Stern Review.

9 Stern Review Chapter 9 using a bottom-up assessment of technologies puts the cost "in the range -1.0 to + 3.5% of GDP" p 239; Chapter 10, using a macroeconomic model of costs, says costs are "most likely to be around 1% of GDP, +/-3%" p 268.

10 Ibid the phrase first appears on page xv

11 Ibid see Figure 6.5c page 17810

and infinite time horizon mean that over half the projected losses this generation will be paying to avoid will not occur until several centuries hence.

Stern justifies his ultra-low discount rate as being rational and ethical –

arguing that discounting for time is irrational and we should value the well-being of future generations as much as our own. Since discounting to infinity at a zero rate would put an infinite value on even the smallest reduction of emissions, he discounts time at 0.1% per annum (pa) to allow for the risk of extinction (for reasons other than climate change). He also recognises that benefits accruing to people with higher incomes are less valuable. So he discounts benefits accruing to future generations by the growth in their incomes relative to today – which he puts at 1.3% pa: hence his total discount rate of 1.4% pa.

• Inconsistent discounting of costs and benefits.

Although Stern discounts benefits of curbing emissions at an ultra-low rate, he does not discount the true cost of doing so – the returns foregone on alternative investments – at the same low rate. As a result, his estimate of the cost of avoiding climate change is understated relative to his estimate of the benefits by a factor of between 2 1/2 and 5 times.

Arguably he is entitled to use a low discount rate, but only if he accepts that, logically, he should advocate investing in a Norwegian-style ‘fund for the future’, not just in mitigating climate change but in any projects with returns above his discount rate until the market rate and his discount rate converge.

Peculiar ethical assumptions.
Normal ethics of external costs would require users of fossil fuels to pay a charge suffcicient if invested at market rates to compensate future victims of suffcicient global warming (which would prompt switching away from fossil fuels if that is less costly than paying the levy). The charge would therefore equal future damages discounted at the market rate. So Stern segues away from the polluter pays principle to base his ethics on a utilitarian welfare maximising approach, which envisages a single "decision-maker acting on behalf of the community and whose role is to improve, or maximise overall social welfare." 12 The ethical values attributed to the perfectly rational decision maker imply that this relatively poor generation should be required to sacrifice up to 5% of their income to ensure that people in 2200, whose average incomes, even on Stern’s most pessimistic scenario, will be over 7 times higher than today’s, do not suffer a 5% loss of income. He castigates those who do not share this view as "not caring for future generations". Yet arguably it is more ethical to care about today’s poor than tomorrow’s rich. Moreover, those who put a supreme value on the existence of the human race would not need to use an ultra-low discount rate to justify action if they believed human survival to be at risk.

12 Stern Review page 3111 What Is Wrong With Stern?

Not discounting for uncertainty. It is common to use a higher rate of discount for greater uncertainty since that attaches less weight to less certain, more distant events. But Stern says the greater the uncertainty about the impact of carbon emissions, the lower the rate of discount should be. He argues that the less certain we are, the wider the dispersion of potential outcomes and incomes; lower incomes reduce the element of his discount rate which reflects the difference between future and current incomes. Conversely outcomes at the top of the potential range of dispersion will be discounted more heavily; so the average will be weighted towards less discounted ‘bad’ outcomes. He tacitly assumes we can be certain about the structure of the future, apart from the dimension of the impact of climate change. In fact, the future is likely to be different in utterly unforeseeable ways. It requires supreme hubris to assume that the only uncertainty about how our actions now will affect the world centruies hence, is the precise magnitude of the impact.

Clutching at catastrophes.
Even Stern’s base case assumes that higher temperatures might precipitate three catastrophic consequences: (i)the release of methane from the tundra or oceans – but this did not happen on a significant sclae during previous periods of rapid warming; (ii) the reversal of the gulf stream - which is not predicted by the IPCC and would offset global warming, scarcely a catastrophe; and (iii) the melting of the icecaps - which the IPCC says will take millennia, giving plenty of time to change course or counteract emissions.

• Denying scientific certainty.

Stern’s team fall back on the suggestion by Martin Weitzman that Stern may be right for the wrong reasons. Weitzman argued that if there is a finite possibility, however small, of an infinitely bad outcome (human extinction) then virtually any cost is worth incurring to prevent it. To forecast infinitely bad outcomes, ironically Stern has to jettison his belief that "the science is certain" and postulate a response of climate to greenhouse gases beyond anything known to physics. Climate sensitivity is not a random variable, so if it is high its impact must currently be concealed by natural variations and should soon become obvious as those fluctuations reverse, giving plenty of time to respond. Also, by Weitzman’s logic we cannot neglect the risk that measures to prevent emissions have infinitely bad outcomes: e.g. reliance on nuclear energy resulting in nuclear proliferation and war; without green house gas emissions we may enter an ice age; etc. And other tiny but terminal risks such as asteroids hitting the earth would compete with global warming for huge outlays.

Cherry picking unreliable studies.
Stern draws heavily on non-peer reviewed and alarmist literature to paint an exaggerated picture of the key risks of global warming:

a)

Hurricanes and storms. A World Bank study shows that Stern’s forecasts of damage to infrastructure from more powerful storms are up to 100 times too large - being based on extrapolating a non-peer 12

reviewed paper which attributed much of the growth of insurance claims (which is mainly the result of more properties being built in storm-prone areas) to greater prevalence of more powerful storms. There is scant evidence of this. The IPCC is uncertain, citing models indicating that the number of storms may decline but intensity may increase.

b)

Food and famine. He neglects scope for adaptation (citing a study showing a 4 degree Celsius rise could cut yields of one crop variety by 70% but assumes farmers will not switch to another variety whose yields would increase – a fact he withholds). He says a 4°C rise would cut world cereal production by 10%. But he accepts that meeting the bio-fuels target will absorb 10% of the world’s arable land. In any case this is insiginificant given the massive scope to boost output by using existing agricultural techniques more widely.

c)

Water supplies. Higher temperatures mean more precipitation overall. But Stern highlights the number of people forecast to suffer increased water stress, although twice as many will enjoy reduced water stress.

d)

Rising sea levels. This is the most iconic fear aroused by global warming but the IPCC says it will take millennia for higher temperatures to melt the ice-caps. Meanwhile the oceans are set to rise at a rate similar to the average of the last 18,000 years. A World Bank study suggests that even Bangladesh can prevent projected storm surges at a cost of barely 1% of its GDP.

e)

Disease. Stern relies on a study which arbitrarily assumes 2% of all deaths from diarrhoeal diseases, malaria and malnutrition are the result of climate change and that this will double for each 1°C rise in temperature. But these are diseases of poverty and invariably disappear as countries experience economic growth.

Neglecting adaptation, reduced vulnerability and technological advances.
Apart from cherry picking alarming studies, Stern systematically downplays or ignores possible trade-offs between adaptation to, and prevention of, climate change; he assumes poor countries remain vulnerable to climate change whereas economic growth makes countries much more resilient; and he neglects likely technological changes – like GM crops, vaccines for malaria and other diseases, sturdier buildings for hurricane zones, etc.

Reliance on models to predict damage.
Despite using alarmist studies to depict a frightening future, his actual estimates of climate damage depend on an essentially arbitrary algebraic formula embedded in the Integrated Assessment Model he uses. This reduces all the consequences of climate change to a single variable and assumes they occur as soon as a given temperature is reached – effectively bringing forward the possible impact of melting ice-caps by millennia. 13 What Is Wrong With Stern?

Underestimating cost of reducing emissions.
Although the IPCC concludes that it is impossible to say whether the cost of preventing global warming would be more or less than the benefits of doing so, Stern claims the costs will be only a fifth to a twentieth of the benefits.

Embarrassingly, given he was head of the government’s economic service, his estimate is well below the UK government’s own estimate of the cost of the Climate Change Act and also below the lowest of 21 studies collated by Stanford University.

He selects the most optimistic estimates which assume costs of alternative energy sources will fall rapidly. Yet if they are set to do so it is foolish to adopt new technologies prematurely while the cost is still so high.

He puts immense faith in Carbon Capture and Storage – as yet commercially unproven - since he assumes 75% of electricity will still be generated using hydrocarbons.

If Stern applied his ultra-low discount rate to the true cost of investing in decarbonising the economy (the returns foregone on alternative

investments), it would increase his cost estimate up to five-fold.

• Sacrificing today’s poor for tomorrow’s rich.

Poor countries are more vulnerable to global warming – because they are poor. The cure for poverty is growth, which requires energy.

Requiring poor countries to replace fossil fuels by renewables costing upwards of twice as much will hinder their growth, leaving them vulnerable to global warming.

Stern admits the bio-fuel target will require 10% of the world’s arable land, driving up food prices by more than the yield loss he expects if temperatures rise 4°C.

Developing countries will account for the bulk of growth in emissions on a ‘business as usual’ scenario as the poorest two-thirds of the world’s population catch up with the most developed nations. So Stern’s crash programme to limit emissions would involve major restraint by them even if developed countries decarbonise almost totally.

Emissions trading would allow rich countries to cut their emissions by less in return for paying poor countries to cut by more, using more costly methods than they would otherwise have done. Subsidies for low carbon development will divert aid from other uses; impose an additional layer of bureaucracy on developing countries; create huge opportunities for abuse; and encourage countries to threaten high emission schemes unless paid to abandon them.

In practice, developing countries have no intention of slowing down their growth while millions of their citizens are living in poverty.

14

Stern presents China’s plans to get back to their previous path of rising

energy efficiency as "cuts" whereas their growth plans imply massive increases in their total emissions.

Policy implications conflict with consensus and governments’ own cost benefit analysis

Stern sets a target of stabilising the atmospheric concentration of carbon dioxide at 500 to 550 parts per million (ppm). This would ultimately require reducing emissions by more than 80% from current levels. Developed countries would have to do so by 2050.

Stern does not evaluate alternatives nor demonstrate that this is the optimum target (nor mention that it was the target already adopted by the UK government).

To achieve this, the price of carbon must be raised by taxing or pricing

emission permits to reflect its social cost, which he puts at $310/ton of carbon rising to $950/ton by 2100.

The consensus of conventional economists was that the optimum path was to intensify the effort more gradually. For example, Nordhaus’s optimum path

involves an initial Social Cost of carbon of $27/ton of carbon to cut emissions by a quarter by 2050 against Stern’s three-quarters.

Gradually intensifying the effort avoids prematurely abandoning existing capacity or adopting new technologies while still too expensive and allows

time to reach firmer estimates of climate sensitivity.

The British government ignored its own impact assessments, which showed

potential costs of its Climate Act were twice the maximum benefits and costs of its Feed-In Tariffs were 20 times their benefits.

The subsequent revision increased benefits of the Act ten-fold by assuming

that the rest of the world follows the UK example, which undermines the case for unilateral action.

Developing countries like China and India have no intention of following suit. The increase in China’s emissions every year exceeds the UK’s emissions, which are just 2% of the world total. And despite Stern’s optimistic belief that public opinion would force countries to adopt and observe stringent international targets, both Canada and Japan have resiled from Kyoto commitments.

15 What Is Wrong With Stern?

Key Recommendations

The government should cease to rely on the flawed Stern Review to justify

policy and should commission a new, independent Review.

The government should prescribe the same discount rate for assessing costs

and benefits of climate policies as it uses for all long-term public projects or explain fully why it is not so doing – and show the sensitivity to alternative plausible discount rates and the Internal Rate of Return of alternative pathways for tackling global warming.

The Review should assess the impact of global warming specifically on the UK and include in figures for UK emissions estimates of carbon emitted to

produce goods imported into the UK.

The Review should assess the cost and benefits for scenarios with varying

degrees of international cooperation. Meanwhile, Parliament should remove the legal requirement on the UK to act unilaterally.

In the absence of a new Review, government strategy should at most involve:

• gradually ramping up incentives to reduce carbon emissions

• cost effective measures to increase energy efficiency

• greater focus on incentivising Research and Development

• acceptance that developing countries need to develop the cheapest

energy sources available to them

• more emphasis on adaptation to climate change as it occurs

• focussing development aid on helping vulnerable countries adapt to

climate change, whatever its cause. 16

Chapter 1 - Background to Stern Review and its Reception

"The effort expended in prising open the oyster led some to overvalue the pearl within". Professor Harry Johnson.

In July 2005, Gordon Brown, then Chancellor of the Exchequer, announced that he had asked Sir Nicholas Stern – an academic economist turned

Treasury official, by then the Permanent Secretary responsible for the Government Economic Service - to undertake a major review of the economics of climate change. Sir Nicholas (now Lord Stern) led a team of 23 Treasury economists and officials, supported by many consultants, who worked on the review for 16 months at a cost of £1.27 million. 13 Their 700-page report, entitled the Stern Review of the Economics of Climate Change, was press released with considerable fanfare at the end of October 2006.

Several features are unusual and affected its initial reception:

• It was first published online and physical copies were only made available

two months later. As a result, the initial response to such a massive work was heavily dependent on briefing material provided by the Review team.

• The media amplified uncritically its most stark and dramatic conclusions.

"Climate change fight ‘can’t wait’"

BBC News

"£3.68 trillion: the price of failing to act"

The Guardian

"The day that changed the climate"

The Independent

"Blair: World needs to act on climate change now"

Daily Mail

"British Government Report Calls for Broad Effort on Climate Issues"

New York Times

"Report’s stark warning on climate"

BBC News Channel

• Although treated in public as an independent study, it was essentially a

government report.

• It was not subjected to independent peer review.

• Rather than analysing a range of possible targets for stabilising emissions,

it focussed on, and recommended, just one - which happened to be the

13 Hansard 13 Jan 2011 Reply by Justine Greening. "This figure does not include the costs of any analysis and research

carried out by other government departments to support the review, nor any follow up work …" 17 What Is Wrong With Stern?

target to which the UK government was already committed (though this was not mentioned in the Review).

The relationship between the Stern Report and the IPCC appears to have been somewhat incestuous. The Stern Review was published in October 2006, whereas the IPCC Fourth Assessment Report (known as AR4) did not appear until 2007. So Stern used the IPCC Third Assessment Report (TAR), published in 2001, as the base for its science, supplemented by studies published since then, many of which were subsequently assessed in AR4. The Stern Review was not peer-reviewed so was theoretically not itself eligible

for inclusion in the AR4. In any case, the final date by which expert reviewers were required to submit their comments for studies to be included in the AR4 was some months before Stern was published. Remarkably, the AR4 nonetheless refers to the Stern Review no fewer than 26 times in 12 different chapters – only two of which relate to the economics of climate change. Indeed the AR4 uses Stern as the sole source of its claim that three-quarters of a billion people in China and India depend on glaciers for their water supply. 14 This raises concerns about the IPCC process. This study nonetheless takes the IPCC assessment of the scientific literature as given, as did Stern.

The Review was opaque as to its key assumptions – notably the discount

rate used - and contained no sensitivity analysis. So it was difficult for commentators to deduce how the Review managed to reach conclusions so widely different from the bulk of the work it was reviewing. The team did subsequently make good this omission by publishing a sensitivity analysis online.

Although the Government cites the Review in defence of its policies, it ignores conclusions which do not help its case. For example, the former Energy and Climate Change Secretary, Chris Huhne, asserts that renewable energy will end up costing less than fossil fuels as they become increasingly scarce. Yet Stern poses the question:

"Will increasing scarcity drive up the relative prices of fossil fuels to choke off demand fast enough?"

and concludes

"There is enough fossil fuel in the ground to meet world demand at reasonable cost until at least 2050".

15

In February 2007, the Yale Center for the Study of Globalization held a seminar bringing Stern and many of the world’s leading environmental economists together to discuss his Review. It received a comprehensive battering, albeit couched in polite academic language. A number of papers criticizing various aspects of the Stern Review were published in the peer-reviewed literature. But this made no impact outside academic circles.

14 Donna Lafromboise IPCC Expose: the delinquent teenager who was mistaken for the world’s top climate expert. The Stern Review seems to rely on an article by Barnett et al in Nature 2005.

15 Stern Review p. 212.

18

Chapter 2 - Key Criticisms of the Stern Review’s

Conclusions

"The science is intricate. But it is a doddle compared to the economics and politics of climate change. Nick Stern has averred that it needs ‘all the economics you ever learnt, and some more’." Lord Rees

16

The Stern Review could have been an admirable basis for a debate on the economics of global warming. It assembles a wealth of information, contains plenty of penetrating insights and makes provocative and challenging judgements. Unfortunately, rather than being used to stimulate public

debate, it has been used to silence dissent from the official orthodoxy - at least in public, if not in academe. It is still routinely invoked by Ministers and in government documents as providing an incontestable basis for their latest measures.

The intelligent lay reader and even the professional economist could not readily work out how the Review had reached its conclusions – though the conclusions themselves seemed clear, dramatic and - to the layperson - plausible.

As a result the Review’s conclusions became established as proven before their rationale was understood or subjected to criticism.

The three principal conclusions were dramatic:

• "If we don’t act, the overall costs and risks of climate change will be

equivalent to losing at least 5% of global GDP each year now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more".

• "In contrast, the costs of action – reducing greenhouse gas emissions to

avoid the worst impacts of climate change – can be limited to around 1% of GDP each year."

• "Our actions now and over the coming decades could create risks of

major disruption to economic and social activity, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century."

Overall, these give the impression that for a modest cost we can prevent

damages which are imminent, would cost us five to twenty times as much and would involve large scale loss of lives and livelihoods. However, these conclusions are highly misleading and misrepresent the body of the Review

16 Royal Society Lecture 5th December 2011

19 What Is Wrong With Stern?

itself. They involve comparing apples and pears, conflating predictions

centuries ahead with the present, inconsistent discounting of costs and benefits, and cherry picking alarmist projections.

Comparing apples and pears

Or rather, comparing a part of an apple with the whole of a pear. Stern compares the cost of reducing emissions not with the reduction in damage as a result of lower emissions but with the total damage caused by all greenhouse gas emissions – both those he plans to prevent and those which will still be permitted plus all those that have accumulated since the industrial

revolution! In Stern’s base case and using his metric, the net benefit from meeting his emission target would actually be equivalent to 3.1% of GDP "now and forever", not 5%. 17

Stern only makes an obscure reference to this issue half-way through his report. He suggests that:

"Allowing for uncertainty, if the world stabilises at 550ppm CO2, climate change impacts could have an effect equivalent to reducing consumption today and forever by about 1.1%."

18

This is somewhat less than estimated by Tol, though on a different basis. The Review is understandably coy about this issue. The larger the difference

between the net benefit of stabilising emissions and the total damage if emissions are not curbed, the more egregious its error in comparing the cost of reducing emissions with the total damage caused by all emissions. On the other hand, the smaller the residual damage caused if we stabilise at 550pmm, the less compelling the case for setting such a low level. Although the Review does not carry out a systematic cost/benefit analysis of different emission stabilisation levels, it does let slip that setting the emission level at 650ppm would only increase damages by the equivalent of some 0.6% of GDP "now and forever".

Describing the distant future as "now"

The statement that the costs of climate change "will be equivalent to losing at least 5% of global GDP

each year now and forever " (emphasis added) gives the impression that we are about to experience a loss of "at least 5% 19 of GDP now" due to global warming. The key words "equivalent to" are invariably overlooked. 20 They refer to the Review’s novel and misleading

17 The Stern Review: a deconstruction: Tol and Yohe, Energy Policy 37 2009.

18 Stern Review page 333.

19 The words "at least" are also contentious. The body of the report shows that a 5% loss of GDP averaged over time is the mean for his Base Line Case, not a minimum. The 95% probability range for this case is between an averaged loss of just 0.6% and 12.3% of GDP. Stern Review Table 6.1 page 186.

20 Even the government does so. For example, the DECC Impact Assessment of the Climate Change Act quotes Stern as

20

practice of projecting by how much unrestricted climate change would reduce GDP each year from now (when the reduction is negligible) to

infinity (when it will be large), discounting it back to the present, and then calculating what constant percentage reduction in GDP, discounted back to the present at Stern’s very low rate of discount, has the same present value. 21 To say this averaged value – which reflects high impacts centuries hence – reflects the impact of climate change on GDP "now" is simply untrue. In fact, far from experiencing a 5% loss of GDP now, the impact of warming could be beneficial now and for several decades since moderately higher temperatures boost crop yields, as do increased concentrations of CO2.

Understating costs

The second conclusion - that costs "can be limited to around 1% of GDP each year" is more optimistic even than the body of the Review, where it says "the expected annual cost … is likely to be around 1% of GDP by 2050 with a range of +/-3%".

22 It is below any of the 21 studies monitored by Stanford University. Moreover, Stern has subsequently doubled his cost estimate, saying that we need to aim for the bottom end of his target range of emission cuts "costing about 2 per cent of global GDP each year". 23 Costs will start to be incurred "now" and for the foreseeable future. Even Stern’s low estimate exceeds the likely cost of climate change this century since the gloomiest scenario which Stern depicts, in which global warming reduces GDP "now and forever" by 14.4%, actually involves losses averaging less than 1% of world GDP over this century: they reach just 0.4% by 2060 and 2.9% in 2100, rising to 13.8% in 2200. 24 So he is now proposing that throughout this century the world should spend over twice his pessimistic estimate of the cumulative damage caused by global warming over the whole of this century (only part of which would be prevented).

Inconsistent discounting of costs and benefits

Although Stern discounts benefits of curbing emissions at an ultra-low rate, he

does not discount the true cost of preventing this – which is the rate of return foregone on alternative investments – at the same low rate. As a result, his estimate of the cost of avoiding climate change is understated by a factor of between 2 1/2 and 5 times. 25 concluding that the cost of climate change if we do nothing "is estimated at 5% to 20% of global GDP now and forever" omitting the words "equivalent to".

21 Stern Review pages 183-5 (Box 6.3)

22 Stern Review Chapter 10 page 267.

23 Stern N. Time for a Green Revolution New Scientist 21 Jan 2009.

24 Stern Review Figure 6.5c page 178.

25 Robert Mendelsohn makes a simiilar point in "A Critique of the Stern Report",

Regulation Winter 2006-2007 21 What Is Wrong With Stern?

Alarmist cherry picking

Stern’s third conclusion gives an overly dramatic picture of the likely damages caused by global warming. To compare it with the impact of two world wars and the Great Depression implies global warming will cause massive loss of life and livelihoods. This is not supported by the text of the report, still less by the IPCC. In fact, the Stern Review projects a world in which, even if we do nothing to prevent global warming, average incomes will rise by, on the gloomiest scenario, seven times and otherwise up to twelve times their current level by 2200. The effect of mitigating global warming would be to ensure incomes are at the high end of that range – at the cost of today’s far poorer generation. Moreover, the main impact of global warming is likely to be on the physical environment – damage to

infrastructure from more frequent and powerful storms and floods and a gradually rising sea-level - not loss of human lives.

It is useful to show Stern Review’s most extreme outcome would mean for

people over the next two centuries using his figures. He shows losses of income per capita for a number of scenarios, of which the most damaging is shown in Figure 1, reproduced below. This figure takes into account all of Stern’s most alarming assumptions. It assumes that no effort is made to reduce ‘business as normal’ emissions of greenhouse gases. It also includes the weighted risk of possible catastrophes (melting ice-caps, reversal of the Gulf Stream, and release of methane clathrates). It adds in the impact of Stern’s ‘High Climate scenario’, which assumes that emission of methane from the soil and frozen tundra amplify global warming. Finally, Stern deducts from GDP the impact of warming on non-market factors such as health, environment and species loss, even though these are not included in GDP. The central estimate for this scenario is a loss of welfare equivalent to 13.8% of GDP per capita by 2200. But the Review also allows a wide range of outcomes by running the model with different values of the key variables. 95% of these runs give losses of less than 7.5% of GDP in 2100 and 35% of GDP in 2200. 22

Figure 1: The impact on GDP of the Stern Review’s most extreme scenario

Source: Stern Review

Table 1 below shows average GDP/welfare per capita for developing countries and industrialised countries assuming losses at these extreme levels occur. Despite these losses, people in developing countries are still expected to have average levels of well-being more than six times their current incomes by 2100 and 20 times by 2200, when their incomes will be two-thirds higher than incomes of people in the industrialised world today.

26

26 GDP per capita in 2100 taken from Scenario A2 in IPCC SRES and projected from 2100 to 2200 at 1.5%pa for developing countries and 0.9% for industrialised countries, giving the overall growth of 1.3%pa indicated by the Stern Review.

23 What Is Wrong With Stern?

Table 1: Stern’s Estimate of the Worst Cost of Global Warming

Scenario A2 adjusting for Stern Review’s highest 95th percentile estimate of costs of climate change assuming High Climate, market impacts, risk of catastrophes, non-market impacts (health, environmental, species loss etc).

Scenario A2

1990

2006

2100

2200

Developing Countries

GDP per capita, no global warming

$900

$1,500

$11,000

$49,000

Max cost of climate change

0

0

$800

$17,200

Net welfare per capita, with global warming

$900

$1,500

$10,200

$31,800

Industrialised countries

GDP per capita, no global warming

$13,700

$19,300

$46,200

$117,000

Max cost of climate change

0

0

$3,500

$41,000

Net welfare per capita, with global warming

$13,700

$19,300

$42,700

$76,000

World total

GPD per capita, no global warming

$3,800

$5,100

$16,100

$58,600

Max cost of climate change

0

0

$1,200

$20,500

Net welfare per capita, with global warming

$3,800

$5,100

$14,900

$38,100

 

 

 

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