Britain's costliest mistake? Lord Stern defends his climate maths

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Analysis As the year winds to a close and a new one begins, it's traditional to think about the future and good resolutions we may be keeping. In particular, we thought it would make sense to take a look at the resolution the UK made a few years ago: to cut carbon emissions on a scale unmatched by any other nation. How's that going, and what will it mean in years to come?

In other words - how much will the struggle against global warming cost the UK? A little? A lot? Will the “cure" hurt us more than the disease? Five years on from the passage of the 2008 Climate Change Act, few people understand the maths behind such calculations.

One of the people responsible for the Act, economist Lord Stern, was recently called upon by Parliament to defend his calculations. In 2007 Stern - then plain Nick Stern - delivered the Stern Review, a massive economic assessment that helped convince MPs that climate mitigation measures would be well worth the cost. Cutting carbon dioxide emissions would cost of just one per cent of GDP, Stern argued, but we’d pocket between five times to 20 times the benefit. Put this way, carbon dioxide reduction was a great investment. A no-brainer.

The result was quite possibly the most expensive legislation ever passed by Parliament.

However, it subsequently emerged that Stern’s maths was very iffy indeed. The economist most cited in Stern’s Review, Professor Richard Tol, an IPCC veteran, was one of its severest critics. In "A Review of the Stern Review" Tol and economics professor Gary W Yohe described how Stern had made a catalogue of errors: including unjustifiable assumptions and double-counting the benefits. Stern’s cost figure was far lower than any other economist. Stern’s figure for the benefits of urgent CO2 limitation were far higher than any other economist, too. Tol wasn’t against making urgent climate policies - but he said that Stern had performed such "substandard analysis” that his calculations had caused great damage to the argument for carbon reduction. Errors that might have been caught by peer review - as a UK government-commissioned work, Stern's review was not reviewed by his peers - remained.

Stern made many controversial assumptions. His cost-benefit ratios ranged from 0.09 to infinity. The vulnerability to damage didn’t change over 200 years, in Stern’s predictions. Farmers would not switch crops if the strain they used became less productive. But perhaps the most questionable was his handling of "discount rates” - the formula used to measure future cost and benefits. Since future generations will be richer, then theoretically it’s cheaper for them, in the future, to take action such as switching to a relatively more expensive fuel, rather than making our grannies suffer fuel poverty today.

"Why should we sacrifice 10 per cent of our income today to make Bill Gates better off?” is how one of Stern’s critics, MP Peter Lilley, expressed this proposition.

Stern sighed and embarked on a long answer. Eventually a conclusion came into sight:

In a world with very imperfect markets, you’ll find many different kinds of discount rates, according to who it is. That's why you would not expect to have same discount rates for all goods, for all activities, for all people. We use different discount rates appropriate for the questions being asked ... It’s a matter of imperfect capital markets – you do not expect those things to be the same.

Stern did concede that in 2006, when the report was written, his team had overestimated growth.

"Looking back at the Stern Review, we were rather optimistic about growth. So I think from that point of view discount rates were possibly on the high side,” he told MPs.

But this wasn’t the point, Lilley replied. You can choose high rates or low rates - you just have to use the same methodology throughout:

"I wasn’t disagreeing with you. Unlike a lot of people, I don't disagree with you. That’s perfectly reasonable as long as you apply it to costs as well as benefits,” said Lilley.

He elaborated:

If I thought there was a serious risk of an ineluctable and unavoidable process that would lead to the extermination, or the immiseration* of humanity, I wouldn’t want to do any discounting - I'd want to stop it … On your forecasts, even on the most severe circumstances that occur - on p178 of your report - you show that the effect of Global Warming for the 95 percentile "will reduce GDP by 37pc below what it would otherwise be in 2200, but even so people will be 7 times better off compared to today. So why should we try and make those people who will be 7 times better off, 10 times better off - at the expense of stopping poor people today from enjoying the benefits of coal and gas?"

Stern replied that if you put it that way, than spending anything today is pointless. It would be better to wait for society to get richer before spending any money:

"If you assume growth then any investment is devaluated in terms of its impact on this growth path, and you could argue against any investment along the lines you've just made.”

Strangely Stern claimed to be using the Treasury’s discount rate set out in the Green Book “for which I was responsible” (it's true that Stern was head of the Government's economic service from 2003, but the Green Book had been written before Stern arrived and wasn’t revised until 2011, by which time he was long gone).

Even more strangely, Stern didn’t actually use the Green Book’s discount rate of 3.5 per cent. He used 2.1 per cent for the current century and 1.4 per cent for long term analysis. If Stern had used the 3.5 per cent rate the government uses for everything else, then the benefits of carbon reduction today would appear as far lower. Ian Byatt, former deputy of the government's economic service, reckoned a 3.5 per cent discount rate would reduce the costs of CO2 emissions from 5 per cent of GDP per year (by 2020) to 1.4 per cent (PDF, p95).

After a few minutes Lilley gave way. Stern seemed relieved to receive much more comfortable questions from friendlier MPs. He told them things were actually far worse than anyone thought, apocalyptically so. Human beings were "rewriting the relationship between humans and the planet”, he told them.

It's definitely one to think about. ®

Useful links

The Stern Review

A Review of the Stern Review. Richard S. J. Tol & Gary W. Yohe's 2008 (free)
What is wrong with Stern? - Peter Lilley

* Immiseration refers to the ever-worsening condition of workers, in terms of real wages and hours worked, that traditional Marxists believe is an inevitable consequence of capitalism. In this metaphor, humans are the workers/consumers and the planet is the "producer". (Regarding the Marxist term, Frankfurt School theorists later proposed that because rulers of a democratic state work on behalf of the electorate - ie, state intervention, including manipulation of markets, trade rates, taxes, competition etcetera actually exists - this trend is mostly mitigated.)

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