The cost of climate action

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Nick stern Sir Nicholas Stern, IG Patel Professor of Economics and Government at the London School of Economics and former Chief Economist of the World Bank

THE CASE FOR ACTION ON CLIMATE CHANGE

A basic conclusion of the Stern Review is that the costs of strong and urgent action on climate change will be less than the costs of inaction and the impacts of climate change under business as usual (BAU). Although they are in the minority, we have come across a number of people who deny the importance of strong and urgent action on climate change and they essentially offer one of, or a combination of, the following arguments. First, there are those who deny the scientific link between human activities and global warming. Second, there are those who, while accepting the science of anthropogenic climate change, argue that the human species is very adaptable and can make itself comfortable whatever the climatic consequences. Third, there are those who accept the science, are sceptical about the idea that humans can adapt to anything but believe the costs involved are just too great and are despondent about the challenge of mitigating climate change. Finally, there are those who accept the science of climate change and the likelihood that it will inflict heavy costs, but simply do not care much for what happens in the future beyond the next few decades.

NO SCIENTIFIC BASIS

For those who fall under the first category of deniers, clearly it is for the science to persuade them otherwise, but the weight of evidence is now such that most people would see this point of view as simply absurd. The February 2007 Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) sets out the evidence in a very convincing and clear way. It confirmed that there is now very high confidence that human activity is warming the climate and that human influences are likely to have been at least five times greater than those due to solar variations. There is now very little justification for believing that the scientific understanding of climate change is fundamentally flawed, or that the remaining areas of uncertainty imply current knowledge is inadequate as a basis for drawing conclusions for policy.

HUMANS CAN ADAPT TO CLIMATE CHANGE

Human beings are incredibly adaptable. Our ability to adapt to changes in climate, and the impacts this will cause, is likely to increase as countries become richer and more technologically advanced. However, there is a limit to adaptation. Under a BAU scenario, the stock of greenhouse gases could more than treble by the end of the century, giving at least a 50 per cent risk of exceeding 5°C global average temperature change during the following decades. This would take humans well into unknown territory and would involve very large movements of population away from the equator. A 5°C increase may not sound like much but it masks significantly higher temperature increases on most land masses. A temperature increase of that magnitude would dramatically change the physical and human geography of the world.

Adaptation will become increasingly difficult as temperatures rise with the costs of adaptation rising at a faster rate than the temperature. While higher GDP should increase adaptive capacity, vulnerability may increase with GDP as more expensive capital is at risk and populations are forced to inhabit increasingly hazardous areas. Some changes in climate are also not amenable to technological improvement in the same way that, say, energy generation or fighting disease is.

The economics of climate change are fundamentally about the economics of risk. If you act on climate change and invest in bringing forward new technologies, and it turns out to be the biggest hoax ever perpetrated on mankind, as a US senator has described, you will still have acquired a lot of new technologies that are probably quite useful. If, on the other hand, you do nothing, you may quickly end up with a lot of irreversible and severe damage from which it will be very hard to extricate yourself. Given the scale of the outcomes that we now have to regard as possible or likely under BAU, maintaining this view must be regarded as reckless.

ACTION IS TOO COSTLY

The third group accept the case for action, but argue that the sacrifice required would be prohibitive, requiring a radical change in our lifestyles. The likely cost of urgent and coordinated action is around one per cent of GDP by mid century. This is not a trivial amount and represents a very significant change in the patterns of energy investment towards low carbon energy technology. But in terms of growth, it amounts to a fraction of a fraction taken off the annual rate. Estimates of the cost of action to reduce greenhouse gas emissions published by the IEA and McKinsey since the Review have been below our estimates.

Computer rubbish The one per cent of GDP reflects the likely costs under a flexible global policy, employing a variety of economic instruments in cost effective ways to control emissions of a broad range of greenhouse gases. It would require clear long term price signals and policy frameworks that encourage technological innovation. In the absence of these factors, or were action to be delayed, the costs could be significantly higher. However, as we argued in the Review, the decision on whether to act now hinges on the question of irreversible outcomes and risks. Decisions taken today will have potentially large and irreversible consequences in terms of climate change impacts; this is not true to the same extent of mitigation costs. Moreover, policymakers can keep cost estimates under review and revise policy in the light of new information. By contrast, the impact from global warming will become increasingly costly to reverse. In part this reflects the fact that damages are caused by the stock of GHGs and not the annual flow, but it also reflects the risks associated with irreversible thresholds and discontinuities. Despondency over the cost of mitigating climate change compared to the cost of business as usual must be viewed as irresponsible.

FUTURE GENERATIONS WILL BE RICHER AND MORE ABLE TO ADAPT

The attitude of the fourth group relates to views on valuing the future and so called ‘discounting’. In the Review, we do discount future damages for the likelihood that future generations will be richer than we are and we account for the risk of extinction. However, applying substantial discounting to the future simply because it is the future would be unacceptable to many, including many of the great economists, such as John Maynard Keynes, Robert Solow and Amartya Sen. This is what some economists would call pure time discounting, and we are convinced that such time discounting at a heavy rate would be viewed by most people as unethical. It involves discrimination between individuals by date of birth and is as though a grandparent is saying to their grandchild, because you will live your life 50 years after me, I place a value of one-quarter on your well being relative to myself and my current neighbours (as would be the case with a pure time discount rate of three per cent), and therefore I am ready to take decisions with severe and irreversible implications for you. Most would regard this as unethical.

Further, it is not possible to read off these ethics from the behaviour of markets, as many recommend. We cannot see a collective expression in the markets of what, acting together, we should do for 100, 150 years’ time. Current market interest rates tell us only about individuals’ willingness, possibly irrational, to invest today for benefits tomorrow through their daily consumption, saving and investment decisions.

How much should society, acting together, spend on unborn generations is a somewhat different question. To use pure discount rates of around three per cent implies valuing impacts on lives in the middle of next century at 1/300 the weight of lives today. And note that the Stern analysis does include treating a dollar to a richer generation as worth less than a dollar to a poorer generation. Indeed this approach to discounting, which takes account of a society’s income levels, reminds us that discounting depends on both growth and distributional outcomes. Various combinations of
these can lead to discount rates at four or five per cent, while also showing the very big damages from BAU.

In any case, pure discounting, at these rates, presupposes the conclusion: if you don’t care about the future and apply that kind of discounting, you won’t care about climate change. You don’t need the science or the economics; further analysis becomes redundant.

THE BASIC QUESTION

It is not necessary to understand the science or economics of climate change in great detail to have a view on the case for robust and urgent action. Our central estimate of mitigation costs for stabilising emissions below 550 ppm CO2e (parts per million of carbon dioxide equivalent – all greenhouse gases expressed as a common metric relative to their warming potential) is one per cent of GDP per annum. The basic question is thus: is it worth paying one per cent of GDP to avoid the additional risks of higher emissions as described in the disaggregated story of consequences? We should recognise the balance of risks. If the science is wrong and we invest one per cent of GDP in reducing emissions for a few decades, then the main outcome is that we will have more technologies with real value for energy security, other types of risk and other types of pollution. However, if we do not invest the one per cent and the science is right, it is likely to be impossible to undo the severe damages that will follow. The case for strong and timely action, supported by well designed economic policies, is overwhelming.

Author

Sir Nicholas Stern, IG Patel Professor of Economics and Government at the London School of Economics and former Chief Economist of the World Bank, led the UK Government commissioned Stern Review on the Economics of Climate Change published in October 2006. He currently holds the IG Patel Chair at the London School of Economics and Political Science.

Picture credits: Icebergs - Milos Peric/iStockphoto; Computer rubbish - Lya Cattel/iStockphoto

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