Stern scare blunted by the figures

On the face of it, Stern accepts Nordhaus's figure: even including risks of catastrophe and non-market costs, he agrees that an increase of 4C will cost about 3 per cent of GDP. But he assumes that we will continue to pump out carbon far into the 22nd century, a rather unlikely scenario given the falling cost of alternative fuels, and especially if some of his predictions become clear to us towards the end of this century. Thus he estimates that the higher temperatures of 8C in the 2180s will be very damaging, costing 11 per cent to 14 per cent of GDP.

The Stern review then analyses what the cost would be if everyone in the present and the future paid equally. Suddenly the cost estimate is not 0 per cent now and 3 per cent in 2100, but 11 per cent of GDP right now and forever. If this seems like a trick, it is certainly underscored by the fact that the Stern review picks an extremely low discount rate, which makes the cost look much more ominous now.

But even 11 per cent is not the last word. Stern suggests that there is a risk that the cost of global warming will be higher than the top end of the UN climate panel's estimates, inventing, in effect, a worst-case scenario even worse than any others on the table. Therefore, the estimated damage to GDP jumps to 15 per cent from 11 per cent. Moreover, Stern admonishes that poor people count for less in the economic calculus, so he then inflates 15 per cent to 20 per cent.

This figure, 20 per cent, was the number that rocketed across the world, although it is simply a much-massaged reworking of the standard 3 per cent of GDP cost in 2100, a figure accepted among most economists to be a reasonable estimate.

Likewise, Stern readjusts the cost of dealing with climate change. The UN found that the cost of 550ppm stabilisation would be somewhere from 0.2 per cent to 3.2 per cent of GDP today; he reports that costs could lie between minus 4 per cent and 15 per cent of GDP. The minus 4 per cent is based on the suggestion that cutting carbon emissions could make us richer because revenue recycling could address inefficiencies in taxation; but the alleged inefficiencies, if correct, should be addressed no matter what the policies about climate change.

The reason Stern nevertheless finds a very low cost estimate is because he only considers models with so-called induced technological change. These models are known to reduce costs by about two percentage points because carbon cuts lead to an increase in research and development, which again makes further cuts cheaper. Thus, Stern concludes that the costs are on average 1 per cent of GDP, and in the summary claims that this is a maximum cost.

The Stern review's cornerstone argument for immediate and strong action is based on the suggestion that doing nothing about climate change costs 20 per cent of GDP now, and doing something only costs 1 per cent. However, this argument hinges on three very problematic assumptions.

First, it assumes that if we act, we will not still have to pay. But this is not so: Stern tells us that his solution is "already associated with significant risks". Second, it requires the cost of action to be as cheap as he tells us, and on this front his numbers are at best overly optimistic. Third, and most significantly, it requires the cost of doing nothing to be a realistic assumption, but the 20 per cent of GDP figure is inflated by an unrealistically pessimistic vision of the 22nd century, and by an extreme and unrealistically low discount rate. According to the background numbers in Stern's report, climate change will cost us 0 per cent now and 3 per cent of GDP in 2100, a much more informative number than the 20 per cent now and forever.

In other words, given reasonable inputs, most cost-benefit models show that dramatic and early carbon reductions cost more than the good they do. Stern's attempt to challenge that understanding is based on a chain of unlikely assumptions.

Moreover, there is a fourth key problem in Stern's argument that has received very little attention. It seems naive to believe that the world's 192 nations can flawlessly implement Stern's multi-trillion-dollar, century-long policy proposal. Will nobody try to avoid its obligations? Why would China and India participate? And even if China got on board, would it be able to implement the policies?

In 2002, China decided to cut sulphur dioxide emissions by 10 per cent; they are now 27 per cent higher despite SO2 being nationally a much bigger health and environmental problem than climate change.

We all want a better world. But we must not let ourselves be swept up in making a bad investment simply because we have been scared by sensationalist headlines.