by Duncan Gromko
Lord Nicholas Stern spoke at an event yesterday at the International Monetary Fund (IMF) and organized by the World Resources Institute (WRI) on climate change and how we should react to it (full powerpoint found here). Lord Stern is most famous for a report that estimated that climate change would cost the world about 5% of global GDP per year. The report also estimated that the cost of mitigating climate change was only 1% of global GDP year. It was an argument that should have appealed to a wide range of people: mitigating climate change is less costly than adapting to it. Lord Stern presented on a number of other issues, but I'm going to focus on his discussion of this report and how it fails to fully reflect the cost of climate change.
This broader cost estimate has led to a number of derivative figures. For one, the cost of climate change has also been put into a dollar amount per ton of CO2 emitted. In other words, Lord Stern's estimate of the cost of climate change is being divided by the total number of tons of CO2 emitted that will get us to his assumed temperature rise. Stern's model put the cost at $85 per ton. The EPA estimated the cost at $24 per ton. Just for context, most discussions of a potential carbon tax in the US have considered a tax of $5-20 per ton.
Another example of pricing climate change is a report by the IMF, which discusses the cost of fossil fuel subsidies. It estimates that the cost of our traditional way of thinking about subsidies (how much the government directly gives to energy consumers or providers) is around $480 billion per year. The IMF also estimates that the "externalized" cost of greenhouse gas emissions - which is the same thing as saying the price of climate change - is another $1.4 trillion per year. This is actually a lower estimate than Lord Stern's estimate since it amounts to an annual 2.5% of global GDP.
That's a roundabout way of saying that economists are helping environmentalists articulate the cost of climate change in a way that policy-makers can understand.
What surprised me most about Lord Stern's presentation at the IMF was how critical he was of this very approach. There are basically three problems.
One problem is with uncertainty in modeling the physical consequences of climate change. As an example, Lord Stern brought up methane trapped in permafrost in the Arctic. As the arctic melts, this huge quantity of methane will be released. Methane is a potent greenhouse gas, so this will raise global temperatures. Which will release more methane. Which will raise global temperatures. These sort of positive feedback loops create a ton of uncertainty for modelers because no one knows when they will be triggered. Lord Stern said yesterday that, since they couldn't accurately predict this feedback loop, they just left it out of the model.
A second problem is modeling the impacts of climate change on human output; even if you can predict how climate will change, it's difficult to predict how humans will react. One example is agriculture in India. The Stern Report simply estimates how agricultural productivity will change for a region facing increased temperatures. It doesn't take into account more complex (and harder to predict) consequences such as reduced water flow from Himalayan glaciers or changes in the timing and quantity of monsoon rains.
Beyond modeling the physical consequences of climate change on human output (like agricultural productivity), a final problem is translating the human output economic values. If you want to get deep into this issue, I recommend this paper by Dr. Joshua Farley (I've also written a short version of Dr. Farley's arguments). One issue that Lord Stern brought up is that any of these cost of climate change models are assuming a constant annual world growth rate of something like 3% GDP, then reducing this estimate by the fraction that they predict climate will affect the economy. This methodology doesn't take into account that the damage caused by climate change will lower the productive capacity of the economy. The flood in Pakistan, for instance, didn't just reduce GDP by x%, it set the flooded region back decades in terms of their development by destroying human and physical capital that Pakistan had invested in.
A related problem is discount rates (considered at length by David Roberts). Essentially, economists compare present and future benefits by reducing the value of benefits by some discount rate. On a personal level this makes sense: would you rather have $100 today or $100 10 years from now? Lord Stern argued, however, that for intergenerational valuations, discount rates undervalue the benefits to future generations. Using discount rates is assuming that people are going to be richer in the future - it's assuming continued economic growth. If people are poorer because of climate change, reduced resource availability, or any other factor, you should actually have a negative discount rate (meaning that benefits tomorrow would be valued higher than benefits today). Lord Stern said that "the discussion of discounting today is truly awful."
It was refreshing to hear one of the biggest intellectual creators of the market-based approach to the environment discussing the problems with it. He argued that as climate scientists and economists are becoming aware of these problems, they are doing a better job of accounting for them in models. I would also add that, disagreements about the accuracy of these estimates aside, this new language that environmentalists have is a powerful tool. For the IMF to say that climate change is "the greatest economic challenge of the 21st century," that represents a huge change in thinking.
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| Lord Stern; Source: Global Risks |
Lord Nicholas Stern spoke at an event yesterday at the International Monetary Fund (IMF) and organized by the World Resources Institute (WRI) on climate change and how we should react to it (full powerpoint found here). Lord Stern is most famous for a report that estimated that climate change would cost the world about 5% of global GDP per year. The report also estimated that the cost of mitigating climate change was only 1% of global GDP year. It was an argument that should have appealed to a wide range of people: mitigating climate change is less costly than adapting to it. Lord Stern presented on a number of other issues, but I'm going to focus on his discussion of this report and how it fails to fully reflect the cost of climate change.
This broader cost estimate has led to a number of derivative figures. For one, the cost of climate change has also been put into a dollar amount per ton of CO2 emitted. In other words, Lord Stern's estimate of the cost of climate change is being divided by the total number of tons of CO2 emitted that will get us to his assumed temperature rise. Stern's model put the cost at $85 per ton. The EPA estimated the cost at $24 per ton. Just for context, most discussions of a potential carbon tax in the US have considered a tax of $5-20 per ton.
Another example of pricing climate change is a report by the IMF, which discusses the cost of fossil fuel subsidies. It estimates that the cost of our traditional way of thinking about subsidies (how much the government directly gives to energy consumers or providers) is around $480 billion per year. The IMF also estimates that the "externalized" cost of greenhouse gas emissions - which is the same thing as saying the price of climate change - is another $1.4 trillion per year. This is actually a lower estimate than Lord Stern's estimate since it amounts to an annual 2.5% of global GDP.
That's a roundabout way of saying that economists are helping environmentalists articulate the cost of climate change in a way that policy-makers can understand.
What surprised me most about Lord Stern's presentation at the IMF was how critical he was of this very approach. There are basically three problems.
One problem is with uncertainty in modeling the physical consequences of climate change. As an example, Lord Stern brought up methane trapped in permafrost in the Arctic. As the arctic melts, this huge quantity of methane will be released. Methane is a potent greenhouse gas, so this will raise global temperatures. Which will release more methane. Which will raise global temperatures. These sort of positive feedback loops create a ton of uncertainty for modelers because no one knows when they will be triggered. Lord Stern said yesterday that, since they couldn't accurately predict this feedback loop, they just left it out of the model.
A second problem is modeling the impacts of climate change on human output; even if you can predict how climate will change, it's difficult to predict how humans will react. One example is agriculture in India. The Stern Report simply estimates how agricultural productivity will change for a region facing increased temperatures. It doesn't take into account more complex (and harder to predict) consequences such as reduced water flow from Himalayan glaciers or changes in the timing and quantity of monsoon rains.
Beyond modeling the physical consequences of climate change on human output (like agricultural productivity), a final problem is translating the human output economic values. If you want to get deep into this issue, I recommend this paper by Dr. Joshua Farley (I've also written a short version of Dr. Farley's arguments). One issue that Lord Stern brought up is that any of these cost of climate change models are assuming a constant annual world growth rate of something like 3% GDP, then reducing this estimate by the fraction that they predict climate will affect the economy. This methodology doesn't take into account that the damage caused by climate change will lower the productive capacity of the economy. The flood in Pakistan, for instance, didn't just reduce GDP by x%, it set the flooded region back decades in terms of their development by destroying human and physical capital that Pakistan had invested in.
A related problem is discount rates (considered at length by David Roberts). Essentially, economists compare present and future benefits by reducing the value of benefits by some discount rate. On a personal level this makes sense: would you rather have $100 today or $100 10 years from now? Lord Stern argued, however, that for intergenerational valuations, discount rates undervalue the benefits to future generations. Using discount rates is assuming that people are going to be richer in the future - it's assuming continued economic growth. If people are poorer because of climate change, reduced resource availability, or any other factor, you should actually have a negative discount rate (meaning that benefits tomorrow would be valued higher than benefits today). Lord Stern said that "the discussion of discounting today is truly awful."
It was refreshing to hear one of the biggest intellectual creators of the market-based approach to the environment discussing the problems with it. He argued that as climate scientists and economists are becoming aware of these problems, they are doing a better job of accounting for them in models. I would also add that, disagreements about the accuracy of these estimates aside, this new language that environmentalists have is a powerful tool. For the IMF to say that climate change is "the greatest economic challenge of the 21st century," that represents a huge change in thinking.
So, it was an interesting presentation - I was surprised and impressed with how critical Lord Stern was of his own approach. Environmental economists have made a concerted effort to value the costs and benefits associated with natural resources, but are still struggling to do so in the neo-classical economic framework. In the mean time, however, these dollar figures still provide an impressive political argument for better management of the environment. As Lord Stern, said, the primary remaining obstacle isn't an understanding of climate, economic analysis, or access to appropriate technology. The obstacle is a lack of political will.
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