Nordhaus vs. Stern
When the Stern Review on the Economics of Climate Change was released a few weeks back, I got a bevy of calls from reporters asking what I thought of it. Of course, it's hard to say anything intelligent about a 700+ page report that was released only hours earlier, so all I could do was quickly peruse the executive summary, speed-glance through the most pertinent sounding chapters, and opine like the wind. While I thought I did a reasonable enough job summarizing the main issues at hand given the circumstances, the experience demonstrates a fundamental problem with journalism that is unlikely to ever go away. To wit, reporters demand an immediate reaction when some new study or paper comes out, and the news cycle doesn't last long enough to allow for particularly informed and/or careful review of many of these said studies or papers. By the time that informed and careful response is ready, reporters have moved on to something else. The deck is stacked in favor of the authors, who seldom have to defend against anything but superficial or relatively poorly-informed criticism in the popular press.
One of the things I was most interested in at the time was what economists who specialized in the economics of climate change had to say about the Stern Review. The leading academic on this subject is William Nordhaus, an economist at Yale (another is Prof. Robert Mendelsohn at the same university. Prof. Mendelsohn's response to the Stern Review will be published in the next issue of Cato's Regulation magazine). When I emailed Prof. Nordhaus about the Stern Review, I got a rather short and vague reply. Nicholas Stern is a good economist, Prof. Nordhaus said, and the report looked like a serious undertaking; the right questions were asked and the answers provided looked interesting. Beyond that, little else. Reporters I talked to told me this is what he had sent them as well. Apparently, Nordhaus was not ready to jump into the discussion yet.
Reporters moved on, but Nordhaus did not. Over the next several weeks, he apparently went to work on the document and by last week he was ready to offer up some thoughts. Despite the fact that this highly credentialed economist finds that "it is impossible for mortals outside the group that did the modeling to understand the detailed results of the Review," his analysis is illuminating. While no reporter is likely to write about Nordhaus' take on Stern now, it is worth your time if you wonder whether an economic disaster of epic proportions really awaits us lest we do something drastic to reduce greenhouse gas emissions. The answer; probably not.
The gist of the matter is this: Academic economists who specialize in climate change generally agree that warming - if the "consensus" of scientific opinion as reported by the Intergovernmental Panel on Climate Change is correct - will only reduce global GDP by 0-3% per year and that those costs won't be evident until well into the future. The Stern Review, however, reports that losses may total as much as 20% of global GDP if warming is left unaddressed. Why the disagreement?
While there are a number of issues in play, the main thing explaining the differing calculations is the extent to which future warming is discounted into the present. Most economist use discount rates ranging from 3-5% when trying to put a price tag on future damages. Stern argues that this is ethically indefensible - losses tomorrow, or even 200 years from tomorrow, are just as worth worrying about as losses today. If you apply a 0.1% discount rate (Stern's figure) rather than, say, a 5% discount rate (my suggestion, which matches the return on Treasury bills - or, put another way, the figure people apply themselves when considering the value of money today versus the value of money tomorrow) or a 3% discount rate (Nordhaus's figure, although he is happy to confess that other figures are perfectly defensible), then you're going to get a huge price tag for global warming. Apply higher discount rates, and the price tag deflates to such an extent that it's impossible to justify spending anything near what Stern wants us to spend to reduce greenhouse gas emissions.
Is Stern right to argue that we are morally required to treat losses to future generations in exactly the same manner that we treat losses to present generations? Not necessarily:
Quite another ethical stance would be to hold that each generation should leave at least as much total societal capital (tangible, natural, human, and technological) as it inherited. This would admit a wide array of social discount rates. A third alternative would be a Rawlsian perspective that societies should maximize the economic well-being of the poorest generation. Under this policy, current consumption would increase sharply to reflect likely future improvements in productivity. Yet a fourth perspective would be a precautionary (minimax) principle in which societies maximize the minimum consumption along the riskiest path; this might involve stockpiling vaccines, grain, oil, and water in contemplation of possible plagues and famines. Without choosing among these positions, it should be clear that alternative perspectives are possible.
Note that if you are an admirer of political philosopher John Rawls - as most of the Left most definitely is - then you should probably embrace the use of a high discount rate.
Anyway, what if we use Stern's discount rate regardless? Nordhaus thinks it leads to palpably ridiculous policy prescriptions:
Suppose that scientists discover that a wrinkle in the climatic system will cause damages equal to 0.01 percent of [global] output starting in 2200 and continuing at that rate thereafter. How large a one-time investment would be justified today to remove the wrinkle starting after two centuries? The answer is that a payment of 15 percent of [the] world's consumption today (approximately $7 trillion) would pass the [Stern] Review's cost-benefit test. This seems completely absurd.
Still happy with a near-zero discount rate? What if we applied that philosophy in other policy arenas where the same issue arises - like, say, foreign policy? Nordhaus echoes an argument I made myself several years ago:
While this feature of low discounting might appear benign in climate-change policy, we could imagine other areas where the implications could themselves be dangerous. Imagine the preventative war strategies that might be devised with low social discount rates. Countries might start wars today because of the possibility of nuclear proliferation a century ahead; or because of a potential adverse shift in the balance of power two centuries ahead; or because of speculative futuristic technologies three centuries ahead. It is not clear how long the globe could long survive the calculations and machinations of zero-discount rate military powers.
Nordhaus's commentary on Stern is only 21 pages double-spaced, and there's more intellectual goodies therein. Read it. Learn it. Live it.
