A Review of the Stern Review on the Economics of Climate Change

“For instance, concerning global climate change, it has been argued that the strong conclusions of the Stern Review were essentially driven by the low assumed discount rate (see, e.g. Nordhaus, 2007 or Weitzman, 2007).”

“Nordhaus (2007) illustrates the importance of these discounting assumptions by comparing the results of three runs of the DICE model. Two of these runs use combinations of the PRTP and η consistent with a SDR of about 5.5%. With these values, the optimal carbon tax in the near term is approximately $35/ton Carbon (or…”

“, how much less we value the future payments in comparison to the present payments of the same size, and there are different views on what the appropriate rate is for climate policy (see, for example, Nordhaus (2007) for a discussion”

“Some argue for a significantly positive discount rate and criticise the use of a near-zero discount rate for climate policy analysis (e.g. Nordhaus, 2007).”

“The considerations adduced here all make a case for giving more weight to the distant future, taking more actions on its behalf, than would be implied by choosing “reasonable” parameters for the fundamental discounting equation.”

“For this reason, the 2006 Stern Review—one of the most comprehensive and longer-term economic cost–benefit analyses of climate change—used a comparatively low average discount rate [6], a decision that was criticized by a number of economists [82].”

“I set them out explicitly here because it is remarkable how tempting such a procedure has sometimes appeared to be (see, e.g. Weitzman 2007a; Nordhaus 2008; IMF 2012: ch. 4) in the context of climate change.”

“These estimates were substantially greater than those produced by many other models, leading several critics to suggest that Stern had inflated his damage figures (Byatt et al., 2006; Lomborg, 2006; Mendelsohn, 2006; Nordhaus, 2007; Tol and Yohe, 2006).”

“Nordhaus (2007) has been adamant about pointing out its implication for the estimation of discount rates and argues that the pure rate of time preference has to be chosen ‘‘descriptively’’, i.e. in away to reproduce interest rates observed in actual markets (Arrow et al., 1996).”

“If an ethical observer knows what the future ethical savings rate should be, then there is another link between η and δ. Dasgupta (2006) and Nordhaus (2007) compare the optimal savings rate implied by η=1 and δ=0.1% (as in the Stern Review) with observed savings rates today.”

“g the discussion in the Introduction; the Varian quote, or the survey paper by Nordhaus (2007) for further details).”

“Stern (2007) obtains a central damage estimate of $85 per ton of CO2, because he uses a much lower discount rate⎯specifically, zero discounting of future utility⎯than the market discount rate assumed in Nordhaus (2007).”

“As a consequence, the sensitivity of optimal environmental policy decisions to the stance taken on discounting has been at the forefront of the economic debate that has followed from Stern (2007); see, for example, Weitzman (2007a) and Stern (2008).”

“Others however have questioned the basis of Stern’s calculations arguing that free markets will price, and then adjust to, the environmental conditions associated with global warming (Nordhaus, 2007).”

“Subjective uncertainty about the trend and volatility in consumption growth, as modeled in Weitzman (2007, 2004) and Gollier (2007), will lead to a declining certainty-equivalent discount rate.”

“For example, Weitzman (2007) argues that Stern places too much emphasis on a cost–benefit analysis and too little on the need for societal insurance against low-probability catastrophic events.”

“Ramsey, 1928; Harrod, 1948; Solow, 1974), Stern (2007) argues on ethical grounds for a near-zero value, while others dismiss this assumption on the grounds that it is inconsistent with actual individual behaviour (e.g. Nordhaus, 2007; Weitzman, 2007).”

“…who focus on climate policy have begun to argue for the importance of including these low probability, high impact events into models on the grounds that not doing so is to overlook what is potentially the most important aspect of any analysis of the economics of climate change (Weitzman 2007).”

“Finally, the possibility of lowprobability high-consequence climate change is not fully included in most analyses (Stern, 2007; Weitzman, 2007; Lonsdale et al., 2008; Nicholls et al., 2008).”

“However, others suggest higher discount rates when assessing economic impacts of climate change (e.g. Nordhaus (2007)).”

“Peasgood (2008) measured the three types of wellbeing for the same population and noted that that, for some people, there were large differences between the various accounts.”

“Consequently, a central concern of the literature on optimal climate policy is to determine the optimal scale of abatement efforts vis-à-vis the business-as-usual scenario and thus to determine the optimal intertemporal trajectory of mitigation (Stern 2006; Nordhaus 2007; Tol 2001).”

“Weitzman (2007) suggests a “trio of twos” giving r = 6 percent.”

“We will also investigate and discuss the structural uncertainties caused by the damage function in Sect.3.5 While time discounting is almost universal in economic analysis, it is also very controversial (e.g.Heal, 1997; Stern, 2007; Weitzman, 2007; Sherwood, 2007).”

“…of economists (e.g. Ramsey, 1928; Harrod, 1948; Solow, 1974), Stern (2007a) has argued that ethical considerations call for a zero or near-zero PRTP, while others dismiss this assumption on the grounds that it is inconsistent with actual individual behaviour (e.g. Nordhaus, 2007a, Weitzman, 2007a).”

“Its commentators suggest higher consumption discount rates (Arrow, 2007, Nordhaus, 2007, Martin Weitzman, 2007: see the debate in the Postscripts to the Stern Review available at www.sternreview.org.uk, as well as the issue of World Economics 7 (4), October-December 2006, and the subsequent Simon…”

“Even if this problem is subsumed in the conventional expected discounted utility approach,Weitzman (2007, 2008) has shown that very deep analytical problems arise because of irresolvable uncertainty about potentially catastrophic and irreversible planetary changes associated with warming.2 Second,…”

“Many studies have addressed the choice of discount rate [Simpson, 2009; Wu et al., 2010; Azar and Sterner, 1996; Conceiç~ao et al., 2007; Weitzman, 2007; Rambaud and Torrecillas, 2005; Guo et al., 2006; Wu et al., 2010; Cai et al., 2002], and a discussion of the issues surrounding this is beyond…”

“T. Schneider), traeger@berkeley.edu (C.P. Traeger), mail@ralph-winkler.de (R. Winkler). assessment model DICE.1 Nordhaus (2007) shows that this difference is almost fully explained by the different assumptions on social discounting as summarized in the Ramsey equation.2 Nordhaus himself favors a…”

“Different objections to Stern’s review, from both ecological economics (Spash, 2007) and mainstream economics (Nordhaus, 2007; Weitzman, 2007), retrace a 30-year-old debate between the two sides on the limits to growth (Funtowicz and Ravetz, 1994; Daly, 1997; Solow, 1997; Stiglitz, 1997; Neumayer,…”

“Let me illustrate by the deeply flawed attempt (see e.g. Nordhaus, 2007 and Weitzman, 2007) to „read off‟ rates for discounting or intertemporal values31 directly from market interest rates: surely an example of the perils of the idea that „all relevant information is in the market price‟.”

“Alternative paths of climate policies and consumption are then evaluated using a social-welfare function that ranks different paths’ (Nordhaus 2007: 690).”

“, impact of climate change on the number of storms or change in mortality) as well as value judgements (e.g., how to monetise non-market damages and how to deal with uncertainty, see Azar, 1998; Dietz et al., 2007; Weitzman, 2007).”

“Most of the evidence on the influence of CBA comes from the US, where Hahn & Tetlock (2008) show that the results of a CBA seem to have little effect on whether a regulation is adopted.”

“This view has been challenged by Stern (2007), who recommended a more vigorous and early response, giving rise to a lively debate (see Arrow 2007, Dasgupta 2007, Nordhaus 2007, Weitzman 2007a).”

“In general, the discount rate is a major determinant of future policies, as highlighted by the debate between Stern and the critics of his 2006 report (Nordhaus, 2007; Weitzman, 2007), so uncertainty over discount rates translates into uncertainty about future policies.”

“In the modified version of PAGE09, the original distribution of the considered variables is kept, but a different definition of SENS has been introduced, in order to take into account Weitzman’s suggestions. In doing so, the SENS distribution has been modified in such a way that up to its median it is distributed acco…”

“Sterner and Persson (2008) amend the DICEmodel by using a utility function that depends upon both consumption and environmental quality, and find that the optimal emission path is highly sensitive to the parameter in the utility function capturing the elasticity of substitution between the two goods.”

“Any national assessment would suffer from a lack of legitimacy in other countries—cf. the cool reception of the Stern Review (Stern et al. 2006) outside Europe.21 Nevertheless, national assessments should be made widely available, e.g., by translation from Russian and Chinese to English.”

“Weitzman (2007) disagreed strongly with the authors of the Stern Review regarding their choice of normative parameters ( ρ and η ), but agreed to some extent that high levels of effort are warranted if uncertainty is taken into account, with a low probability of very strong damages on aggregate…”

“In stark contrast, other discussions of climate change (Lomborg 2004; Weitzman 2007; Nordhaus 2008) have tended to use discount rates in the region of 4 − 6% p.a. Stern concludes that widespread and immediate action to mitigate climate change would be cost-effective, whereas analyses such as…”

“Economists have played a central role in defining the key elements of the debate on climate change following publication of the Stern Review (Stern 2007) and the ensuing debates (e.g., Nordhaus 2007; Sterner and Persson 2008; Weitzman 2007).”

“Its most famous use stems from Weitzman’s (2001) ‘Gamma Discounting’paper.”

“However, Weitzman (2007) has criticized these findings by saying that there are certain uncertainties associated while measuring the impacts of climate change and conclusion are drawn by Stern (2006) are based on assuming a very low discount rate.”

“Using a near-zero discount rate of the kind proposed by the Stern Review, the answer is that society should pay a substantial fraction of a year’s consumption today to remove the wrinkle (see Nordhaus, 2008).”

“There is a large and rapidly growing literature on climate change (Stern 2007; Nordhaus 2007; Weitzman 2007 and references therein).”

“Of course, climate change could also be framed as primarily an ethical issue (Gardiner 2011), or as primarily an economic issue (Nordhaus 2007; Stern 2007; Tol 2006).”

“Economists have previously highlighted several economic modeling choices that can have very large effects on the policy recommendations of these IAMs, including the choice of discount rate (Dasgupta 2007; Nordhaus 2007; Weitzman 2007) and the curvature of the damage function (Ackerman et al.”

“…Review of the Economics of Climate Change (Stern, 2006) used a relatively low social discount rate of 1.4% in concluding that the benefits from avoiding climate change outweigh the costs of avoiding it, although the Stern Review was much criticized for this choice of discount rate (Nordhaus, 2007).”

“The extreme sensitivity of the SCC (or the benefit-cost ratio of mitigating climate change) has been remarked on by other authors, including most recently Weitzman (2007),as discussed above.”