The Stern Review is four years old but remains a vital tool for Copenhagen’s policy-makers. It shows them exactly what not to do, says Robert O. Mendelsohn
Across the West, we hear the increasingly shrill prophesies that climate change will destroy the earth. The solution proposed is to adopt a new world order with regulations that will dramatically change the global economy. Against this backdrop, world leaders will meet in Copenhagen in a few days’ time to discuss whether such upheaval can be justified. And it is a subject on which economists have plenty to say.
Simply put, the costs of ‘abatement’ — the carbon reduction plans being advocated in Britain and many other countries — must be weighed up against the benefits. For example, one cost is that of more expensive, ‘greener’ energy forms — and the cost of economic potential forfeited by not having as many choices of energy in the future. The benefit, of course, is the mitigation of damage that might otherwise come from climate change.The goal of society should be to find the greatest net benefit.
We run into problems when climate change advocates focus on only one side of the equation: how to cut the potential damage by the greatest amount, no matter what the cost. Such an approach is not balanced.
Perhaps the best known of the numerous attempts to assess the economics of climate change is the report by Lord Stern four years ago at the request of the then Prime Minister Tony Blair. For many, including Lord Stern himself, the report represents a coherent justification for an aggressive climate change policy which was (and remains) the policy of the British government.
But is it really a suitable benchmark for our approach to climate change policy? It might not be. It advocated stabilising greenhouse gases in the atmosphere at 550 parts per million of carbon dioxide equivalents, thereby limiting long-term warming to between 2°C and 3°C and effectively ending global warming as early as 2050.
Economists had, until Stern, argued that this target was not efficient because the costs would far outweigh the benefits. But Lord Stern introduced a new set of assumptions.
First, that damage from climate change will be more than the empirical evidence currently suggests — and by a factor of between 10 and 100 times. Second, that the cost of action — or ‘abatement costs’ — would be about ten times lower than they are now. Third, that the interest rate must be near zero.
Crucially, the Stern Review looked at just two scenarios: business as usual, and the radical carbon reduction programme which it outlined. Moderate plans were not assessed.
In the past four years, the Stern Review has been critiqued by a number of economists. And it is hard to argue that it provides economic justification for aggressive abatement policies, as some claim it does.
First, the problem. The empirical scientific evidence, as reported by the IPCC, makes clear that burning fossil fuels leads to emissions of greenhouse gases which are accumulating in the atmosphere and warming the planet. However, the evidence is quite unclear about precisely how much damage this is causing.
Considerable uncertainty surrounds many factors. The trajectory of future emissions, the magnitude of the resulting climate change, the way that ecosystems and ice shields are going to respond, and the consequences for human populations. Contrary to Lord Stern’s suggestions, most of the evidence suggests that the net effect of warming will be only moderately harmful over the next century, with only a small probability of dramatic consequences for the next 90 years. Nor is the effect uniform: some places will suffer, but others will benefit. Damage would, of course, be high if nobody adjusts to climate change — by building better infrastructure, etc. But people will adjust, certainly if the developing world becomes as rich as the projections in the IPCC report suggest.
Only if everything goes wrong simultaneously will the environmental damage turn out to be anywhere near the level required economically to justify the aggressive carbon reduction policies being advocated by Lord Stern.
If society opts for stricter targets for carbon emissions — which is the goal for many at the Copenhagen summit — we will all be very dependent on rapid technological advances. For example, the technology needed to hold greenhouse gas concentrations at the levels demanded by climate zealots (no more than 450 parts per million by volume) do not yet exist. So those who advocate these carbon reduction targets are rather boldly assuming that new technologies will become available quickly at a reasonable cost. If that does not happen, then these targets can only be met by deep reductions in global economic output over several decades. In short, these strict targets could be dangerously expensive. This is the economic flaw in their argument.
This has obvious implications for the Copenhagen summit. Extreme targets should be abandoned in favour of a mild global climate change policy that tightens over time as the problem worsens. Looser targets both give society more time to find new technology and require less abatement. In short they are cheaper, and that means we can adjust to them more easily.
And there are better reasons to choose less stringent targets. If the costs of the programme are very high, the incentives by each country to cheat will be high and the international treaty will probably be weak. However, if the costs are low (that is, the targets are reasonable), every major polluting country in the world could afford to join. The worst environmental outcomes could be avoided and the treaty could be binding.
Greenhouse gas policies should be more proportional to the risks associated with them. The damage of a ton of greenhouse gases rises as the concentration of greenhouse gases rise. The optimal policy should reflect this fact. Overall abatement costs are also expected to fall over time as technology advances. Both of these forces suggest that abatement should be phased in over a period of time. Policies should be dynamic: starting modestly and then increasing as damages rise.
There is an inherent danger in taking the most extreme measures to combat climate change that the environmental advocates demand. If the programme is too expensive, the world may well choose not to have any effective climate policy at all. In this case, the perfect may become the enemy of the good.
Robert O. Mendelsohn is the Edwin Weyerhaeuser Davis Professor of Forestry and Environmental Studies at Yale University.
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