A flawed conversation about the Stern Review

Posted on 3 Apr 2014 in

An article published on 2 April by ‘The Conversation’ by Professor Richard Tol, under the headline ‘IPCC report shows Stern inflated climate change costs’, contains a number of significant errors and misrepresentations.

Professor Tol attempts to compare the estimates of the costs of global warming cited in the ‘Summary for Policymakers’ of the contribution of Working Group II to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC), which was published on 31 March, with the findings of Chapter 6 of the ‘The Economics of Climate Change: The Stern Review’, published in 2006.

Professor Tol claims that the IPCC concluded that “global warming of 2.5°C would cost the equivalent to losing between 0.2-2.0% of annual income” and describes this as being “in sharp contrast” to the findings of the Stern Review. But the comparison is completely invalid because the estimates in Chapter 6 of the Review on ‘Economic Modelling of Climate-Change Impacts’ apply to the impacts of unmanaged climate change due to much higher levels of global warming than 2.5°C.

By quoting selectively from the IPCC Summary, Professor Tol also provides an entirely misleading impression of the reliability of the estimates of the aggregate economic impacts of climate change. The Summary actually states:

“Global economic impacts from climate change are difficult to estimate. Economic impact estimates completed over the past 20 years vary in their coverage of subsets of economic sectors and depend on a large number of assumptions, many of which are disputable, and many estimates do not account for catastrophic changes, tipping points, and many other factors. With these recognized limitations, the incomplete estimates of global annual economic losses for additional temperature increases of ~2°C are between 0.2 and 2.0% of income (±1 standard deviation around the mean) (medium evidence, medium agreement). Losses are more likely than not to be greater, rather than smaller, than this range (limited evidence, high agreement). Additionally, there are large differences between and within countries. Losses accelerate with greater warming (limited evidence, high agreement), but few quantitative estimates have been completed for additional warming around 3°C or above.”

So Professor Tol ignores the IPCC’s careful explanation that 0.2-2.0% is probably an under-estimate because it omits consideration of many of the impacts of climate change, including potentially catastrophic risks.

recent paper in the ‘Journal of Economic Literature’ by Robert Pindyck, Professor of Economics and Finance at Massachusetts Institute of Technology, points out that the economic models used to generate many estimates of economic impacts contain “crucial flaws that make them close to useless as tools for policy analysis” and that “the models’ descriptions of the impact of climate change are completely ad hoc, with no theoretical or empirical foundation”.

It is perhaps less surprising that Professor Tol also neglects to mention that the 0.2-2.0% figures are currently disputed by one of my colleagues, Bob Ward, because they are based substantially on one of Professor Tol’s papers which has been found to contain a number of mistakes.

One of the main aims of the Stern Review was to perform a proper comparison of the costs and benefits of action against climate change, measured over appropriate timescales. Professor Tol describes the calculations in Chapter 6 of the Stern Review as “an arcane bit of welfare economics”. In fact, the Review applied the balanced growth equivalent, which essentially measures the utility generated by a consumption path in terms of the consumption now that, if it grew at a constant rate, would generate the same utility. The balanced growth equivalent was first described in a paper in the ‘Journal of Economic Theory’ in 1972 by Nicholas Stern and James Mirrlees, who was awarded the Nobel Memorial Prize for Economics in 1996. Despite his comments in the article, Professor Tol clearly likes the Stern and Mirrlees method of balanced growth equivalent so much that he used it in one of his own journal papers.

Elsewhere in the article, Professor Tol asserts that “next week IPCC Working Group III will conclude that the Stern Review grossly underestimated the costs of bringing down greenhouse gas emissions”, but this is nothing more than pure unsubstantiated speculation that lacks any factual basis.

Professor Tol goes on describe the Stern Review, which was commissioned by the UK Prime Minister and Chancellor of the Exchequer, as so-called ‘grey literature’ (meaning documents and reports that have not been subjected to the same level of independent peer review as papers in academic journals), claiming it “has no place in the IPCC’s work”. That may be Professor Tol’s personal belief, but it is not consistent with the IPCC ‘Procedure on the use of literature in IPCC reports’, which states

“Priority should be given to peer-reviewed scientific, technical and socio-economic literature if available. It is recognized that other sources provide crucial information for IPCC Reports. These sources may include reports from governments, industry, and research institutions, international and other organizations, or conference proceedings.”

Professor Tol’s personal beliefs about ‘grey literature’ has led him to purge all references to the Stern Review from Chapter 10 of the new IPCC report , on which he is one of two Coordinating Lead Authors. It is a clear example of how Professor Tol has imposed his own individual beliefs on the IPCC assessment process, which is supposed to provide an objective review of the overall evidence.

He also appears unaware that the results of Chapter 6 of Stern Review were included in a peer-reviewed paper by Simon Dietz, Chris Hope and Nicola Patmore, which was published in ‘Global Environmental Change’ in 2007.

Professor Tol moves on to claim that Chapter 6 of the Stern Review used a single discount rate. This is a falsehood  which he also attempted to circulate in a Foreword for a campaign pamphlet by Peter Lilley MP for Lord Lawson’s Global Warming Policy Foundation (Professor Tol is a member of the Academic Advisory Council of the Foundation.

In fact, Chapter 6 of the Stern Review made use of multiple discount rates, because each discount rate will be affected by the changes in the state of the world. This is implicit in the standard approach to discounting pioneered by Frank Ramsey. For Chapter 6, the Review used the information about how global gross domestic product (GDP) would be affected by the impacts of the baseline climate scenario, taking into account the uncertainties across 1000 runs, to estimate global welfare costs. This meant converting per capita global GDP at each point in time between 2001 and 2200 into consumption, then calculating the social utility of per capita consumption, before multiplying by global population.

This calculation for each of the 1000 model runs also took into account, through a discount rate, the standard economic assumption that the extra utility produced by additional consumption falls as the level of consumption rises. In essence, this means that an extra pound is considered to be worth more to a poor person than it is to a rich person. It also corresponds to our tendency to insure against the risk of extreme impacts which render us substantially worse off, even though we know the insurance companies make money out of us.

This assumption places greater weight on near-term consumption than on consumption in the distant future, because in most scenarios for climate change, the world will be richer in the future as a result of economic growth. However, these model runs also acknowledged that climate change could substantially reduce consumption growth in the future. Different impacts across the 1000 runs resulted in different growth rates, and required different discount rates.

This approach to discounting was emphasised throughout the Stern Review, particularly in Chapter 2 which states: “The discount rate is the rate of fall of the discount factor. There is no presumption that it is constant over time, as it depends on the way in which consumption grows over time”, and “a single constant discount rate would generally be unacceptable for dealing with the long-run, global, non-marginal impacts of climate change”.

Professor Tol accuses Nicholas Stern of putting himself in the “position of a colonial ruler, governing the savages against their will – but in their own interest”. Yet Professor Stern’s approach to social discounting and pure-time discounting rate is standard in the field of public sector economics. Frank Ramsey, whose approach to discounting is the workhorse of economics, described pure-time discounting, which Professor Tol recommends, as “defective imagination”. Roy Harrod, John Maynard Keynes, Bob Solow and James Mirrlees agreed.

Amusingly, Professor Tol also criticises the Stern Review for using “a discount rate (sic)…far lower than the official discount rate of Her Majesty’s Treasury”, seemingly ignorant of the fact that the Treasury discounting guidance was published while none other than Nicholas Stern headed the Government Economic Service and was Deputy Permanent Secretary of the Treasury. The Treasury rate was designed for marginal changes over short time periods, such as in assessing the costs and benefits of building a bridge, not for large-scale, long-term and potentially irreversible changes such as those associated with climate change. As I have indicated, because these change the state of the world, they change the appropriate discount rate.

Professor Tol argues that that the economic impact of climate change is small: “half a century of climate change at this rate would do perhaps as much damage as losing one year of economic growth”. Once again, this ignores the uncertainties highlighted by the scientific consensus which includes impacts such as dramatic ice sheet melt and drastic sea level rises, large-scale droughts and famine, extreme rainfall, biodiversity die-back and disease, not to mention conflict and migration, each one of which alone would amount to far more than a year’s growth. Even the worst case scenario outlined in the Stern Review of losing the equivalent of 20% of global GDP, is based on model runs that show the world would be several times richer next century.

Nicholas Stern has subsequently, and rightly, admitted that “the modelling in the Stern Review also likely understated the risks”. This is the reverse of what Professor Tol implies, but is in line with the evolving science outlined by the IPCC. Emissions are growing faster than the Review predicted, while the absorptive capacity of the planet is less than was predicted at the time. The Stern Review’s projections also reflected the limitations of the models at the time when it was carried out.

Finally, Professor Tol complains that the estimates of the impacts of unmanaged climate change contained in Chapter 6 of the Stern Review are “dominated by unlikely events in 200 years’ time”. This statement exposes the fundamental flaw in Professor Tol’s understanding of the risks of climate change, which the Stern Review was careful to avoid.

One cannot expect to assess and manage the risks of climate change using economic methods and models that simply are not up to the task of capturing the huge scale of the potential risks, such as irreversible melting of the Greenland ice sheet.

The figures cited by Professor Tol from the IPCC report for additional warming of 2°C do not provide a guide to the risks for further warming of 4°C or more, which the IPCC warns is a possibility by the end of this century on current rates of greenhouse gas emissions. Importantly, the figures, as the IPCC acknowledges, do not capture the potential for huge loss of life from catastrophic events. Most economists working in this area recognise these shortcomings, while Professor Tol apparently does not.

So when Professor Tol ends his article by alleging that the Stern Review uses “accounting tricks and dubious assumptions”, he is merely highlighting how different his own personal approach is to that of the rest of the research community.

Dimitri Zenghelis is Co-Head of Policy at the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science. He was also a member of the team at Her Majesty’s Treasury which prepared the Stern Review.