Stern’s Critical Flaws

by Iain Murray on November 22, 2006

in Environment, Precaution & Risk

The Stern Review on the economics of climate change has come in for more criticism from experts in the field. Following Richard Tol, we now have Yale’s William Nordhaus (PDF link), who says:

The Stern Review is a Prime Minister’s dream come true. It provides decisive and compelling answers instead of the dreaded conjectures, contingencies, and qualifications. However, a closer look reveals that there is indeed another hand to these answers. The radical revision of the economics of climate change proposed by the Review does not arise from any new economics, science, or modeling. Rather, it depends decisively on the assumption of a near-zero social discount rate. The Review’s unambiguous conclusions about the need for extreme immediate action will not survive the substitution of discounting assumptions that are consistent with today’s market place. So the central questions about global-warming policy — how much, how fast, and how costly — remain open. The Review informs but does not answer these fundamental questions.

On top of this, we have Partha Dasgupta, Frank Ramsey Professor of Economics at the University of Cambridge, who finds (PDF link):

[T]he conclusion I have reached is that the strong, immediate action on climate change advocated by the authors is an implication of their views on intergenerational equity; it isn’t driven so much by the new climatic facts the authors have stressed. In what follows I make clear what I mean by that.

[...]

Are the numbers taken in the Review to reflect the two ethical parameters compelling? I have little problem with the figure of 0.1% a year the authors have chosen for the rate of pure time/risk discount (delta). But the figure they have adopted for eta – the ethical parameter reflecting equity in the distribution of human well-being – is deeply unsatisfactory. To assume that eta equals 1 is to say that the distribution of well-being among people doesn’t matter much, that we should spend huge amounts for later generations even if, adjusting for risk, they were expected to be much better off than us. To give you an example of what I mean, suppose, following the Review, we set delta equal to 0.1% per year and eta equal to 1 in a deterministic economy where the social rate of return on investment is, say, 4% a year. It is an easy calculation to show that the current generation in that model economy ought to save a full 97.5% of its GDP for the future! You should know that the aggregate savings ratio in the UK is currently about 15% of GDP. Should we accept the Review’s implied recommendations for this country’s overall savings? Of course not. A 97.5% saving rate is so patently absurd a figure that we must reject it out of hand. To accept it would be to claim that the current generation in the model economy ought literally to impoverish itself for the sake of future generations. The moral of such finger exercises such as the one above is that we should be very circumspect before accepting numerical values for parameters of which we have little a-priori feel.

To sum up the economic criticisms of the report: to obtain his estimate of the damage of global warming, Stern used a worst-case scenario for temperature rises, exaggerated the effects with his “high-climate” model, applied a discount rate which is questionable and a view of the value of inter-generational equity which is absurd in its implications. In none of these cases did he apply sensitivity tests by, for example, using an IPCC scenario that shows less warming, developing a model in which the effects of global warming are easily adapted to by a richer society, using a market discount rate or taking into consideration the idea that our descendants will be quite capable of looking after themselves. Each of these tests separately would have produced lower cost estimates. Together, it is plausible to think they might have delivered a cost figure for global warming that is negligible. A civil servant who is looking to provide unbiased advice to his Minister would have, out of the sense of pure duty alone, provided those sensitivity tests without fear or favor. That Sir Nicholas did not is, in my view as a former civil servant in Her Majesty’s Government, nothing short of unethical.

In short, with economic models, as with any model, garbage in, garbage out. What is so dispiriting about the Stern Review is that Sir Nicholas Stern has reduced the noble position of Chief Economic Adviser to Her Majesty’s Government to that of Garbageman.

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