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The criticism of the Stern Review Disagree with some issue Hannu Vehniäinen Michael Schmidthaler The Economics of Climate Change Table of Contents • Introduction • Tol/Yohe article – Agreement – Disagreement • Nordhaus article – Agreement – Disagreement • Other opinions • Personal thoughts • Conclusion Summer 2008 Economics of Climate Change 2 Agreement with the Review Tol/Yohe Summer 2008 • There is an economic case for climate policy • The cost of any climate policy increases with delay • The prospects of large costs in the future justify actions now Economics of Climate Change 3 Disagreement with the Review Tol/Yohe Summer 2008 • No new estimates of impacts and costs • Very low discount rate • Low estimates for the cost of climate change policy • The cost and benefit estimates do not match Stern’s policy conclusions. • No need for suspect valuations • Credibility problem Economics of Climate Change 4 No new estimates Tol/Yohe Summer 2008 • Stern Review reviews existing material. • Why are numbers so far outside the range of the previous published literature? • Range of benefit-cost estimates from 0,09 (0.3%of GDP/3,5%of GDP) to infinity (Zero abatement costs) • Impacts are counted up to 2200, but cost estimates stop in 2050 Economics of Climate Change 5 No new estimates Tol/Yohe • The figures of the Stern review rely on previous studies, yet yield different expectations on costs and benefits Source: TOL, R.,S.,J; YOHE, G.,W., 2006 Summer 2008 Economics of Climate Change 6 High valuation of climate change impacts is due to 3 factors Tol/Yohe Summer 2008 • Low discount rate • Double counted risk • Vulnerability constant over very long periods of time Economics of Climate Change 7 Low discount rate Tol/Yohe Summer 2008 • High valuation of climate change impacts • Low discount rates produce high discounted damages • In this case it is chosen so low that 40% to 50% of calculated damages come from the “residual”, i.e. costs that occur beyond the modeled timeframe of 200 years. Economics of Climate Change 8 Tol/Yohe Low estimates for the cost of climate change policy • Shortened time horizon over which they are calculated • Omission of the economic repercussions of dearer energy, • Ignoring the capital invested in the energy sector. Summer 2008 Economics of Climate Change 9 Low estimates for the cost of climate change policy Tol/Yohe • Stern underplays the uncertainty in emission reduction costs • Stern also emphasizes uncertainties concerning the damages of climate change • Using Dennis Anderson‘s result is far more optimistic than most of the other studies • 1%GDP loss (Stern) vs. 2,2% (EMF21) Summer 2008 Economics of Climate Change 10 Tol/Yohe Low estimates for the cost of climate change policy • Anderson‘s Analysis lacks the possible effects of higher energy prices, which will reduce energy demand w/o climate policies. (overestimating the costs) • Does not include the impacts on economic growth (underestimating) • Not include impacts on capital stock turnover (major factor in emission reduction) Summer 2008 Economics of Climate Change 11 Tol/Yohe Cost-benefit estimates do not match the review‘s policy conclusions • Stern does not conduct a proper optimization exercise • If the impacts of climate change are as dramatic and if the costs of emission reduction are as small as reported, then a more stringent concentration target should have been proposed. Summer 2008 Economics of Climate Change 12 Tol/Yohe Cost-benefit estimates do not match the review‘s policy conclusions • Stern overestimates the impacts of climate change real benefits of reduction are lower • Stern sets reductions goals to low (550ppm CO2e) • Previous studies/policies have higher standards • UK has already set a 550ppm policy in 2000 Summer 2008 Economics of Climate Change 13 Tol/Yohe Cost-benefit estimates do not match the review‘s policy conclusions • The review does not conduct a solid benefitcost analysis, but comparse C-B only for one specific target (the all-present 550ppm level) • Stern should compare MC to MB, rather than Total Costs to Total Benefits • Anderson‘s falling MAC are contrary to most of the EMF21 findings (Stern: sub-optimal) • MDC are very hight in comparison to other studies Summer 2008 Economics of Climate Change 14 Tol/Yohe Cost-benefit estimates do not match the review‘s policy conclusions • MDC are very high in comparison to other studies Source: TOL, R.,S.,J; YOHE, G.,W., 2006 Summer 2008 Economics of Climate Change 15 Tol/Yohe Cost-benefit estimates do not match the review‘s policy conclusions • Reasons why Stern did not recommend a more stringend policy (inconsistency): – sub-optimal benefit cost analysis – questionable decline in MAC – rising of MDC Summer 2008 Economics of Climate Change 16 No need for suspect valuations Tol/Yohe • A strong case for emission reduction even in the near term can be made without relying on suspect valuations and inappropriate summing across the multiple sources of climate risk. • Doing nothing in the short term is not advisable even on economic grounds. Summer 2008 Economics of Climate Change 17 Credibility problem Tol/Yohe Summer 2008 • Alarmism supported by dubious economics born of the Stern Review may further polarize the climate policy debate. • Economic estimates are vulnerable to criticism, but climate risks are evident • More chaos generated instead of focusing on the review‘s core messages Economics of Climate Change 18 Additional flaws of the report Tol/Yohe Summer 2008 • The impacts of climate change on agricultural productivity (esp. Africa) • Economic development is estimated to high. E.g. Africa shows only minor signs of convergence. (Agriculture has to increase) • Diseases as consequence of climate change are no problem in developed countries. (which Stern predicts) Economics of Climate Change 19 Additional flaws of the report Tol/Yohe Summer 2008 • Estimates of catastrophic events are extrapolated from other studies without recognizing the outcomes of less pessimistic studies • Poverty projections ignore differences in spatial and income classes • Generally: Stern uses the most pessimistic study in the literature for water, agriculture and health Economics of Climate Change 20 Criticism of the used methodology Tol/Yohe Summer 2008 • The PAGE2002 IAM model is not sufficient to provide robustness and diversity • The model assumes no connection b/w vulnerability and economic development. • Reproducibility of the underlying calculations and assumptions is not provided. (crucial for any scientific standard) Economics of Climate Change 21 Criticism of the used methodology Tol/Yohe Summer 2008 • Double counting of certain parameters leads to higher estimates of the impacts • Model implies “no-learning” behavior (neither about the climate system itself nor about impacts of climate change) Economics of Climate Change 22 Action now? Tol/Yohe Summer 2008 • Stern (as well as others): proves the need for action in order to limit the likelihood of crossing a certain temperature threshold • Policy problem: applying a scarcity rent to the current emissions • Delay CANNOT BE a least cost approach Economics of Climate Change 23 Action now? Tol/Yohe • Little debate on the necessity of action, but on the way of conducting emission reductions • Various studies propose different actions – Immediate emission reductions – R&D on carbon-neutral technology – Institutional development Summer 2008 Economics of Climate Change 24 Policy implication of the Review Tol/Yohe Summer 2008 • Stern‘s problem of rather confusing, instead of convincing arguments • Should focus on the schematic portrait of climate risks instead of economic estimates • Credibility problem is caused by contradictory messages accross the review Economics of Climate Change 25 Tol‘s integrated approach Costless mitigation with a global welfare function Source: David Anthoff1, Richard S.J. Tol Summer 2008 Economics of Climate Change 26 Tol‘s integrated approach Costless mitigation with a regional welfare function Source: David Anthoff1, Richard S.J. Tol Summer 2008 Economics of Climate Change 27 Conclusions TOL/YOHE Tol/Yohe Summer 2008 • Stopping or slowing climate change require deep emission cuts everywhere • Time horizon: 50-100+ years • Stern‘s review misses an opportunity of having greater impact in order to mitigate climate change Economics of Climate Change 28 Nordhaus article • The author of the article, William Nordhaus, is the Sterling Professor of Economics at Yale University • This article is the most well-known criticism against Stern review • How much and how fast should we react to the threat of global warming? Summer 2008 Economics of Climate Change 29 Background Nordhaus article Summer 2008 • Stern Review is ordered by British Government • Stern Review is above all political document • results of Stern Review are dramatically different comparing to earlier economic models that use the same basic data and analytical structure Economics of Climate Change 30 Agreement Nordhaus article Summer 2008 • Nordhaus admits that climate change is a major issue • Something have to be done • Stern review links both economic and environmental issues Economics of Climate Change 31 Disagreement • Discount rate • Uncertainity of future • political of scientific report? Summer 2008 Economics of Climate Change 32 Discount rate • Stern assumes the economic growth rate of 1,3 % • discount rate of 0,1 % • the real interest rate is 1,4 % • Consumption elasticity γ = 1 • discount rate have a large impact when counting net present values • Nordhaus uses term ”near-zero discount rate” Summer 2008 Economics of Climate Change 33 Discount rate • the social reasoning for discount rate is largely irrelevant • are the generations equivalent with each other? • Review does not consider alternative approaches to critical reasoning of discount rate Summer 2008 Economics of Climate Change 34 Example of discount rate • present value of €1000 after 100 years with variable interest rates Summer 2008 Economics of Climate Change 35 Discount rate • Stern motivates the discount rate of 0,1 %, cause there are no reason for set different generations to different situation • How willing we are to make sacrifices for future’s generations? Summer 2008 Economics of Climate Change 36 Discount rate • consumption per capita is now approximately $10 000 • in the year 2200 the amount is $130 000 (by 1,3 % growth of output) • how much we should reduce your consumption? Summer 2008 Economics of Climate Change 37 Example Summer 2008 Economics of Climate Change 38 Discount rate • Stern says that with the 1 % sacrifice from GDP we will avoid the 5 % damage in GDP • In that example with Stern’s numbers it’s cool • but if the interest rate is bigger? • that’s the main point in criticism of Stern review Summer 2008 Economics of Climate Change 39 Discount rate • this is a cost-benefit issue • the criticism does not critize the policy against climate change but the the timeline of the acts Summer 2008 Economics of Climate Change 40 Discount rate • Nordhaus suggest different policy against climate change – first we should invest in technology and human capital – later deeper emission cuts • ”Stern review’s approach is inefficient, because it invests too much in low yield abatement strategies too early.” Summer 2008 Economics of Climate Change 41 Uncertainity of future • Nordhaus does not recommend sharp sacrifices now, cause the future is uncertain – think about the world 200 years ago • as said he emphasize investing in technology Summer 2008 Economics of Climate Change 42 Nordhaus’ DICE-model • Dynamic Integrated model of Climate and Economy • Nordhaus try to find optimal climate policy • DICE calculate capital investment and GHGreductions that maximize a social welfare function – discount rate 1,5 % – consumption elasticity 2 Summer 2008 Economics of Climate Change 43 DICE-model • analytical structure is similar to that in the Stern Review • Nordhaus makes three runs to find the optimal policy – DICE-2007 model – Stern review (near-zero discount rate) – near-zero discount and recalibrated consumption elasticity Summer 2008 Economics of Climate Change 44 Results • Run 1 – optimal carbon price • in the year 2015 $35 per ton C • in 2050 $85 per ton C • in 2100 $206 per ton C – social cost of carbon • in 2015 also $35 per ton C – optimal rate of emission cuts • 14 % in the year 2015 • 25 % in 2050 • 43 % in 2100 – this leads to 2.3 degrees temperature increase from 1900 to 2100 Summer 2008 Economics of Climate Change 45 Results • Nordhaus counted run 2 with the same assumptions, but different discount rate • Review estimates that the current social cost of carbon is $350 per ton C – optimal carbon price • in the year 2015 $360 per ton C – optimal rate of emission cuts • 53 % in the year 2015 • real returns are too low and savings rates too high compared to market data Summer 2008 Economics of Climate Change 46 Results • Run 3 – optimal carbon price • in the year 2015 $36 per ton C – why it looks so similar even though discount rate is so small? – Ramsey’s rule Summer 2008 Economics of Climate Change 47 Results Summer 2008 Economics of Climate Change 48 Conclusion about the results • there are many perspectives to view the future costs and benefits policies to slow global warming • these figures illustrate that it is not only the discount rate which determines the carbon tax – but the combination of the discount rate and consumtion elasticity work through the rate of return on capital Summer 2008 Economics of Climate Change 49 Political of scientific report? • Gordon Brown ”ordered” the report about the economical effects of climate change • there are no rules about government reports produced by scientists • review is not a standard academic analysis • it was published without peer review • written pretty rapidly Summer 2008 Economics of Climate Change 50 Conclusion • Harry Truman: ”Economists would always say, on the one hand this and on the other hand that.” • Stern review really gives clear answers • Nordhaus find that the conclusions of the Stern review will not survive with more consistent assumptions Summer 2008 Economics of Climate Change 51 Other Opinions • Most economists (Solow, Stiglitz, Wolfowitz, et.al) support the conduct and findings of the Stern Review • Especially after the 4th Assessment report of the IPCC was published, scientific evidence is clearly favoring Stern‘s conclusions • Some methodological drawbacks are challenged by various economists Summer 2008 Economics of Climate Change 52 Other Opinions “When the history of the world's response to climate change is written, the Stern Review will be recognized as a turning point. Sir Nicholas and his team have provided important intellectual leadership as humanity engages with its greatest challenge. While the details will be debated, the main thrust of the report is clear and compelling — the expected benefits of tackling climate change far outweigh the expected costs.” • Cameron Hepburn Oxford University Summer 2008 Economics of Climate Change 53 Personal Opinion • Stern provides a well-written state-of-the-art review on the most pressing issues • Disagreement of means of approach, ethics and conduct, rather than methodological flaws – The global distribution of temperature increase which is not considered appropriately (“equity weight”) – Ethic concerns: distant from real-worldconsequences and sterile (political, social and human consequences) Summer 2008 Economics of Climate Change 54 Questions 1. Which are the main flaws of the Stern review that Nordhaus mentions? Summer 2008 Economics of Climate Change 55 Questions 2. How does Nordhaus argue in favour of his opinion of the optimal GHG emission cut policy? Summer 2008 Economics of Climate Change 56 Questions 3. What's the politic/science dilemma of the Stern Review? Summer 2008 Economics of Climate Change 57 Questions 4. Does the critic diminish the conclusions of Stern Review? (your personal opinion?) Summer 2008 Economics of Climate Change 58 Questions 5. What kind of other critic have you heard from the media? Is that critic valid? (Not only concerning the Stern Review but the entire Climate Change debate) Summer 2008 Economics of Climate Change 59 Questions 6. Tol and Yohe mention the credibility problem that is caused by using biased parameters in Stern’s calculations of impacts and costs. What are these? Can you propose other possibilities? Summer 2008 Economics of Climate Change 60 Questions 7. How is it possible that Stern apparently suggests a less stringent policy mix than other studies using some of the same research results? Is there an advantage to that (i.e. not having too ambiguous goals that are possible to reach)? Summer 2008 Economics of Climate Change 61 Questions 8. What do you think about the review in general? Is the critique appropriate? Do you have any thoughts about that issue? - meant to be a question for all of you who have a) strong arguments PRO or CON b) not been heard sufficiently throughout the class c) not been awarded enough grade points during this class…. and who want some! Summer 2008 Economics of Climate Change 62