Stern Review Strikes Out with Professional Economists

Washington, D.C., February 13, 2007—When members of the Senate Energy and Natural Resources Committee sit to hear the testimony of Sir Nicholas Stern on the economics of climate change today, they may want to take his remarks with a grain of salt.

Stern, an economics advisor to the British government, made waves recently with the release of a report on the future economic impacts of climate change. His dramatic findings seemed to reinforce the alarmist predictions of catastrophic climate change, but his calculations have been accumulating an impressive list of critics.  

The passages below are just a few of the critical reactions to the Stern Review which have come from experts in international, natural resource and development economics:

 

“The discount rate used is lower than the official recommendations by HM Treasury. Results are occasionally misinterpreted. The report claims that a cost-benefit analysis was done, but none was carried out. The Stern Review can therefore be dismissed as alarmist and incompetent.”

“If a student of mine were to hand in this report as a masters thesis, perhaps if I were in a good mood I would give him a D for diligence; but more likely I would give him an F for fail.”

―Dr. Richard Tol, Michael Otto Professor of Sustainability and Global Change, Hamburg University

 

“[Stern] makes numerous new assumptions that cause the estimated damages from climate change to be far more severe than previous estimates. The report also makes several strong assumptions that lower the estimated abatement costs. Finally, the report does not consider any policy alternatives other than its own abatement strategy and doing nothing, thus ignoring the possibility of an optimal abatement path that is apart from its own proposal. These characteristics raise serious questions about the soundness of the report’s policy recommendation.”

“[T]he analysis needs to be based on solid science and economics before hundreds of billions of dollars per year are invested in abatement.”

―Dr. Robert O. Mendelsohn, School of Forestry and Environmental Science, Yale University

 

The Stern Review is a Prime Minister’s dream come true. It provides decisive and compelling answers instead of the dreaded conjectures, contingencies, and qualifications. However, a closer look reveals that there is indeed another hand to these answers. The radical revision of the economics of climate change proposed by the Review does not arise from any new economics, science, or modeling. Rather, it depends decisively on the assumption of a near-zero social discount rate. The Review’s unambiguous conclusions about the need for extreme immediate action will not survive the substitution of discounting assumptions that are consistent with today’s market place. So the central questions about global-warming policy – how much, how fast, and how costly – remain open. The Review informs but does not answer these fundamental questions.

―Dr. William Nordhaus, Sterling Professor of Economics, Yale University

 

Are the numbers taken in the Review to reflect the two ethical parameters compelling? I have little problem with the figure of 0.1% a year the authors have chosen for the rate of pure time/risk discount (delta). But the figure they have adopted for eta – the ethical parameter reflecting equity in the distribution of human well-being – is deeply unsatisfactory. To assume that eta equals 1 is to say that the distribution of well-being among people doesn’t matter much, that we should spend huge amounts for later generations even if, adjusting for risk, they were expected to be much better off than us. To give you an example of what I mean, suppose, following the Review, we set delta equal to 0.1% per year and eta equal to 1 in a deterministic economy where the social rate of return on investment is, say, 4% a year. It is an easy calculation to show that the current generation in that model economy ought to save a full 97.5% of its GDP for the future! You should know that the aggregate savings ratio in the UK is currently about 15% of GDP. Should we accept the Review’s implied recommendations for this country’s overall savings? Of course not. A 97.5% saving rate is so patently absurd a figure that we must reject it out of hand. To accept it would be to claim that the current generation in the model economy ought literally to impoverish itself for the sake of future generations. The moral of such finger exercizes such as the one above is that we should be very circumspect before accepting numerical values for parameters of which we have little a-priori feel. What we should have expected from the Review is a study of the extent to which its recommendations are sensitive to the choice of eta. A higher figure for eta would imply greater sensitivity to risk and inequality in consumption, meaning that it could in principle imply greater or less urgency in the need for collective action on global warming. Whether it is greater or less would depend on whether or not the downside risks associated with the warming process overwhelm growth in expected consumption under business as usual. To put it more sharply, a higher value of eta could imply that the world should spend more than 1% of GDP on curbing emissions, or it could imply that the expenditure should be less. Only a series of sensitivity analyses would tell. Curiously, the Review doesn’t report any such sensitivity analysis.

―Sir Partha Dasgupta, Frank Ramsey Professor of Economics, University of Cambridge

 

The Stern Review sides with those who believe in a low discount rate, arguing that the only ethical reason to discount future generations is that they might not be there at all — there could be some cataclysmic event like a comet hitting the earth that wipes out all life. The report assumes that the probability of extinction is 0.1 percent per year. For all intents and purposes, this implies a social rate of discount that is effectively zero, implying almost equal weight to all generations. The report not only chooses to weigh all generations’ welfare almost equally, it also makes an extreme choice when specifying the relationship between consumption and welfare. These choices together imply that a 1 percent reduction in consumption today is desirable if it leads to slightly more than 1 percent increase in the consumption of some future generation, even though, in the model, future generations will be much wealthier than the current generation.

―Dr. Hal Varian, Professor of Business, Economics and Information Management, University of California, Berkeley

 

“Despite using many good references, the Stern Review on the Economics of Climate Change is selective and its conclusion flawed. Its fear-mongering arguments have been sensationalized, which is ultimately only likely to make the world worse off.”

“The Stern review…analyzes what the cost would be if everyone in the present and the future paid equally. Suddenly the cost estimate is not 0% now and 3% in 2100–but 11% of GDP right now and forever. If this seems like a trick, it is certainly underscored by the fact that the Stern review picks an extremely low discount rate, which makes the cost look much more ominous now.

But even 11% is not the last word. Mr. Stern suggests that there is a risk that the cost of global warming will be higher than the top end of the U.N. climate panel’s estimates, inventing, in effect, a “worst-case scenario” even worse than any others on the table. Therefore, the estimated damage to GDP jumps to 15% from 11%. Moreover, Mr. Stern admonishes that poor people count for less in the economic calculus, so he then inflates 15% to 20%.

This figure, 20%, was the number that rocketed around the world, although it is simply a much-massaged reworking of the standard 3% GDP cost in 2100–a figure accepted among most economists to be a reasonable estimate.”

―Dr. Bjørn Lomborg, Director, Copenhagen Consensus Center and Adjunct Professor, Copenhagen Business School

 

“We would emphasise in particular two interrelated features of the Stern Review:

• it greatly understates the extent of uncertainty as to possible developments, in highly complex systems that are not well understood, over a period of two centuries or more

• its treatment of sources and evidence is persistently selective and biased.

These twin features have combined to make the Review a vehicle for speculative alarmism.

We also endorse, from our own analysis, the judgement of our colleagues that the Review:

• mishandles data

• gives too little attention to actual observation and evidence, as distinct from the results of model-based exercises

• takes no account of the failures of due disclosure, and the chronic limitations of peer reviewing, that have been characteristic of work relating to climate change which governments have commissioned and drawn on.

As to specifically economic aspects, we have noted among other weaknesses that the Review:

• systematically overstates projected costs of climate change, partly though by no means wholly as a result of its failure to acknowledge the scope for long-term adaptation to possible global warming

• underestimates the likely cost—including to the world’s poor—of the drastic global mitigation programme that it calls for

• proposes worldwide adoption of a specially low rate of interest for discounting the costs and benefits of mitigation, on the basis of inadequate analysis and without regard for the problems and risks that would result.

“So far from being an authoritative guide to the economics of climate change, the Review is deeply flawed. It does not provide a basis for informed and responsible policies.”

―Sir Ian Byatt, Chairman, Water Industry Commission for Scotland

―Dr. Ian Castles, Visiting Fellow, Australian National University and former head of the Australian Bureau of Statistics

―Dr. Indur M. Goklany, Office of Policy Analysis, U.S. Department of the Interior

―Dr. David Henderson, Visiting Professor, Westminster Business School and former chief economist for the Organization for Economic Cooperation and Development (OECD).

―Lord Lawson of Blaby, member of the House of Lords Select Committee on Economic Affairs and former Chancellor of the Exchequer

―Dr. Ross McKitrick, Associate Professor of Economics, Guelph University

―Julian Morris, Executive Director, International Policy Network and Visiting Professor, University of Buckingham

―Sir Alan Peacock, Honorary Professor of Public Finance, Heriot-Watt University and former Chief Economic Advisor, UK Department of Trade and Industry

―Dr. Colin Robinson, Emeritus Professor of Economics, University of Surrey

―Lord Skidelsky, Professor of Political Economy, University of Warwick