I don't believe the costs of climate change estimates in the Stern Review

Yesterday I looked at the benefits and costs of climate change mitigation from the Stern report, estimates vary from 5% to 20%. None of the newspaper accounts mentioned the time paths of these estimates so I speculated what they might look like and then discounted the benefits and costs of climate change mitigation policies. Knowing full well that I probably got most of that wrong I jumped to chapter 6 of the Stern report, "economic modelling of climate-change impacts," and read the key messages. I was shocked to read this:

Using an Integrated Assessment Model, and with due caution about the ability to model, we estimate the total cost of BAU climate change over the next two centuries to equate to an average reduction in global per-capita consumption of 5%, at a minimum, now and forever.

Those 5% costs of business as usual (BAU) begin today and continue for 200 years. And there's more ...

Adding in:

• non-market environmental and health impacts increases the annual cost, beginning now, to 11% of current world GDP,
• increases in the magnitude of climate response to CO2 due to new scientific evidence increases the cost to 14% of GDP, and
• weighting the impact on poor countries higher than rich countries increases the cost to 20% of GDP (the only number the NYTimes reported yesterday)

Back to the report:

Putting these three additional factors together would increase the total cost of BAU climate change to the equivalent of around a 20% reduction in current per-capita consumption, now and forever. Distributional judgements, a concern with living standards beyond those elements reflected in GDP, and modern approaches to uncertainty all suggest that the appropriate estimate of damages may well lie in the upper part of the range 5 – 20%.

Wow. These numbers are incredibly high. Higher than any previous cost estimate which are reviewed in Figure 6.2:

On the horizontal axis is global mean temperature and on the vertical is the  cost of climate change in % of lost GDP. The extremes are the well known Mendelsohn and Nordhaus estimates. The costs from Mendelsohn are very low, indistinguishable from the horizontal axis. The costs from Nordhaus start small at low temperature increases and rise at an increasing rate with temperature. The highest cost is 11%.

So where does the Stern Report deviate, from these well known cost estimates? In other words, how in the world do the costs start at 5% (20%) and stay constant over 200 years?

The analysis is conducted with a new model, Policy Analysis of the Greenhouse Effect 2002 (PAGE2002), that takes account of market impacts, nonmarket impacts and potentially catastrophic events. The initial runs look reasonable, here is Figure 6.5d, that includes all scenarios:

This shows that the % loss in GDP from 2000 to 2200 begins low and rises to 5.3% (the baseline climate change scenario, market impacts and the risk of catastrophe), 7.3% (high climate change scenario, market impacts, and risk of catastrophe) and 13.8% (high climate change scenario, market impacts, nonmarket impacts, and risk of catastrophe).

Note that the 2200 endpoints are very close in value to the annual cost estimates, "now and forever", summarized above. How can this be?

Answer: I don't know. The report goes from the familiar looking graph above measuring impacts as we know them to something called "balanced  growth equivalents" via, what appears to me as, some tortured logic.  I've never heard of any of this stuff, which doesn't invalidate the analysis (I've never heard of a lot of things that I should have heard about), but makes me a squemish when the next bottom line we're referred to is a welfare cost equivalent to the 5% loss of GDP every year from 2000 to 2200. That is a tremendous increase from a familiar analysis to an unfamiliar analysis.

I don't believe it.

So maybe 5% is the average cost using the discount rate of 0.1% used in the report (a very low rate but maybe appropriate for climate change policy)? I tried to approximate the increasing costs in the graph above and found that the average annual cost is 1.46%, much less than 5%.

I wish I could figure out how we get up to 5%-20% annual costs. [Next day update]

See pp 159-163 of chapter 6 to read it for yourself.

Also, check out Tim Worstall's blog for a chapter by chapter critique of the Stern Review (not Report, as I write above; yet, right now, I'm feeling too lazy to correct it). He is much less accepting of everything else than I am. And, he points out that the review team is more than happy to run mid-level scenarios and scary scenarios, but they don't run the low-level scenario. This gives the entire report the whiff of bias.

Update: The 5% to 20% cost estimate gots legs. Here is something from Kristof's editorial in the NYT (Select: $$$):

If emissions are not curbed, climate change will cut 5 percent to 20 percent of global G.D.P. each year, declared the mammoth report. “In contrast,” it said, “the costs of action — reducing greenhouse gas emissions to avoid the worst impacts of climate change — can be limited to around 1 percent of global G.D.P. each year.” Some analysts put the costs of action higher, but most agree that it makes sense to invest far more in alternative energy sources, both to wean ourselves of oil and to reduce the strain on our planet.

I agree with the next paragraph:

We know what is needed: a carbon tax or cap-and-trade system, a post-Kyoto accord on emissions cutbacks, and major research on alternative energy sources. But as The Times’s Andrew Revkin noted yesterday, spending on energy research and development has fallen by more than half, after inflation, since 1979.

But I'd like the economic justification, a comparison of benefits and costs, to make more sense.

Comments

[Tim Haab]

Nice work. I should probably take a look at this thing, huh?

[John Whitehead]

An idiot check would be appreciated.

[AdamSmithee]

A brief look at the Annex to Chapter Two of the report suggests what might be driving the results. It looks like the review discounts future benefits on two grounds: (i) we might all be extinct due to nuclear war, meteor strike, other; (ii) we'll be richer in the future, and there's a declining marginal return to income. It doesn't discount, as is usual economic practice, purely because stuff in the future is worth less to us than stuff today. There is a discussion of the ethics of such a calculation in the annex.

[John Whitehead]

AdamSmithee,

The diminishing marginal utility of income is put forth in chapter 6 and I think it is appropriate.

So, we're richer in 2100-2200 and each additional dollar earned in those years is worth less than an additional dollar today. Wouldn't that make future negative impacts less severe? not more?

John

[Dano]

Look at Tim Worstall's blog for a critique? Sacre bleu! Don't you guys want to be credible?!?

Anyway, your point is valid but there are an increasing number of studies out there that are finding the same thing: costs are not as high as the do-nothingers said at the beginning. IOW: their studies have been...er...audited and found wanting.

The difficulty is figgerin' out how many people will live in areas that will have a 30-50 cm rise in sea level, and what sort of issues will that create.

E.g. - by 2050 we'll have 9B people, more demand on land and water for food and filtration from the nitrates, and a 50cm rise will create climate refugees and we'll lose some of our rice-growing land and Shanghai will be living on former farmland. That's why it's likely really expensive - food will be expensive because we likely won't be shipping it all over the world by then.

Some of them OSU boys probably have some figgers about how much grain is grown in Bangladesh & how many acres/capita them people over there live on...

Best,

D

[AdamSmithee]

John-- yes, it would make the 2100 impact less severe in 2006 dollars, but adding together the declining marginal utility of a dollar with an accounting for the risk of there being no one around to suffer the consequences of global warming still gives you a discount rate below that you'd get from using LIBOR, or 10 percent, or whatever is yout usual preferred hurdle rate. Because the benefits of avoiding climate change are far in the distance, a low discount rate makes those benefits look bigger in 2006 dollars.

[Richard Tol]

To John Whitehead:

It takes some study, but one can sort of reconstruct what Stern did.

The 5-20% is the annuitised impact, for a 0.1% pure rate of time preference.

The annual damages start relatively low, but escalate in 22nd century -- because the model overlooks technological progress and adaptation.

Then, there is a good bit of double-counting plus a fair bit of "there are no estimates so the impact must be high" type of reasoning.

All that almost gets you there. I'm working on the final parts.

[Carl Marks]

Someone also needs to explore the Al Gore angle on this one, we need to know exactly how much involvement he had in this project.

[Dano]

The annual damages start relatively low, but escalate in 22nd century -- because the model overlooks technological progress and adaptation.

It does? It isn't reflected in GDP growth?

Best,

D

[David Jeffery]

Yes, that sneaky Al Gore, infiltrating the British Treasury and telling them how to conduct their economic analysis.

[Al]

How much of the temperature increase (if there is a temperature increase) is due to variances in the Sun's output? Why have there been so many major climate changes over time on Earth? We have so little evidence that points to man as the culprit yet people all to easy want to shift resources to solving the "problem"?

These reports seem to get wackier and wackier.

It projects out 200 years and we can't say with much certainty what will happen next year!

[Don Lloyd]

What if we separate the problem into two parts? Impact and reflected valuation.

Using the reflection methodology, whatever it is, what would be reflected to the present of any single future year of a reduction of say, 5% economic growth, to flat?

Without changing anything else, all subsequent years would also be 5% lower, but discounting more than one year to the present would seem to be overkill when compared with the alternative of simply offsetting the future by one year.

I have no idea whether this analogy has any connection to the actual report methodology.

Regards, Don

[Charles Young]

Sorry to harp on about discounting, but I think John agrees with Stern and everyone else that $100 adds less welfare if income is $100,000 than if it is $10,000. Now many of the costs in the earlier years impact tropical and low-lying countries with low incomes. $100 of costs to them have greater impact on world welfare. This is one of the reasons the report gives for grossing up to the 20% figure - though it is admittedly misleading to say 20% of GDP, since GDP is not a measure of welfare. I suppose "global welfare" just didn't fit in the headline! (Discounting for income is also the reason why Nobel prize-winner Thomas Schelling has advocated using negative discount rates for climate change measures).

I think John needs to be clear about whether or not he accepts the validity of discounting for higher incomes. If so, the lower figure will not be plausible. If not, then there is no justification for saying that by the time the costs appear, we will all be richer and better able to cope with them.

I note, though, that even the lower figure of 1.46% of GDP that he tentatively advances for the costs of global warming is still 46% in advance of Stern's cost estimate, so I hope he will be enthusiastically supporting Stern's policy recommendations.

Personally, I believe it is the costs that are over-estimated, and that many of the costs of changing our carbon-guzzling habits are like the costs of changing a heroin-user's or a smoker's habit - they seem unbearably high as long as the habit has its grip, but if the lifestyle is changed, the new one will eventually be found to bring benefits that were not foreseen at the time. An economist has no alternative measure of the cost of, say, giving up smoking than to offer the smoker as much money as it takes, each time he reaches for a cigarette, to get him to put it back. This, of course, comes out at a rather high figure, but economics, which always unrealistically assumes unchanging preferences, offers no justification for a lower figure.

[John Whitehead]

Charles,

My enthusiasm for climate change mitigation is dampened as the benefits approach the costs. Both estimates are point estimates and have large error bands around them. There is a good chance that the costs will actually outweigh the benefits, due to statistical uncertainty, even when the net benefits are positive.

But yes, I think we should be doing something. I'm an advocate of a higher gas tax, carbon trading and public research into alternative fuels. But, I think we should start slow and ramp up over time as the costs of climate change become more clear.

And see my mea culpa today and a bit more on this topic.

John

[Charles Young]

John

I'm glad you're in favour of those things, though I'm not clear what is the point of carbon trading except in the context of a cap - I hope you're in favour of that also.

Following your mea culpa, the gap between estimated costs and benefits has now widened from the 46% you believed yesterday back to - I'm not sure exactly where, but somewhere between 46% and 500%. Stern does treat the margins of error pretty much as any good economist should, but in the end it becomes optimistic, and perhaps unrealistic, to hope that the number of standard deviations on each of them is such as to make what appears to be the smaller actually the larger.

[John Whitehead]

Charles,

Gotta have a cap.

If I had to pick a discount rate I'd pick 2% so the net present value of mitigation would be about 0.25% of GDP. For each $100 of GDP the net benefits are 100*.0025 = $0.25. Not much efficiency gain there.

But, efficiency is only one part of the decision making process. We must also consider spatial and temporal equity. For those reasons I'm in favor of proceeding with climate change mitigation policies. But that's just my subjective opinion (as Tim says, the human in me).

The net benefits calculation is more objective (as Tim says, the economist in me).

My objection is the misuse of economics to convince people to try to do something, as if economics was all that matters.

John

[joshua corning]

It does? It isn't reflected in GDP growth?

yes, GDP is not a good measure of wealth...iPods and blogs DVDs did not exist 20 years ago.

Plus per capita consumption of gas and energy and water was higher 20 years ago....none of this is reflected in GDP.

[Dano]

The 'it' I italicized referred to the modifier statement the model overlooks technological progress and adaptation.

I refer in the other Stern thread to a discussion here that further discusses this problematic statement, among other things (including spell check in Firefox 2.0).

Best,

D

[joshua corning]

The 'it' I italicized referred to the modifier statement the model overlooks technological progress and adaptation.

Yes I saw that and I demonstrated with my examples that GDP is not a good measure of technological progress and adaptation...the report may or may not take these into account but if it is relying on GDP then the report is relying on a faulty indicator and/or measure.

sorry if I was not clear...i should have quoted the full post.

[joshua corning]

http://www.opinionjournal.com/extra/?id=110009182

Lomborg goes after the stern study as well...

[Mark Bahner]

Ho, ho, ho!

That Figure 6.5d is a doozy! Essentially zero impact (less than 2 percent of GDP in the worst case) out to 2050, and the worst case is below the reported 5% even out to 2075.

By my reckoning, the world GDP per capita circa 2075 ought to be a bit shy of $1 million. (That's right...$1 million per year, per hydrocarbon-based person.)

http://markbahner.typepad.com/random_thoughts/2004/10/3rd_thoughts_on.html

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