Notes on The Stern Review on the Economics of Climate Change

The Stern Review addresses global climate change and the profound economic implications it holds for both current and future generations. This pivotal report emphasizes the critical necessity of integrating economic considerations into the policymaking process as we combat climate change.

Economists are encouraged to reconsider traditional concepts such as risk, uncertainty, and discounting in the light of climate change, which fundamentally alters their impact on economic analysis. The review serves as a comprehensive economic analysis commissioned by the UK government, reflecting the urgent need for a coordinated response to climate challenges.

Sir Nicholas Stern, a highly-respected economist known for his expertise in environmental and developmental economics, leads this review. He advocates for urgent action against climate change, warning that the anticipated severe economic impacts—if left unaddressed—could dwarf any costs associated with proactive mitigation measures.

Key Findings from the Stern Review

• Main Argument: The Stern Review posits that immediate and significant actions to reduce greenhouse gas emissions are imperative, as the benefits of early action far outweigh the costs associated with such initiatives. Ignoring these measures could lead to irreversible damage to the planet and substantial economic losses.

• Economic Analysis: The review relies on a very low discount rate to assess long-term climate policy, arguing that the high risks and uncertainties related to climate change justify prioritizing long-term sustainability over short-term financial benefits. It suggests investing in mitigation strategies as a form of insurance against potential catastrophic events, which underscores the need for a shift in how economic value is perceived in the context of environmental degradation.

Economic Framework

• Interest Rates and Discounting: The choice of discount rate significantly influences the outcomes of economic analysis regarding climate change. The review's conclusions stem from utilizing a very low social discount rate, which raises questions about its appropriateness and implications for future generations' well-being. A low discount rate places greater importance on future generations' interests, suggesting that we should act now to protect their prospects.

• Ramsey Equation: The review utilizes the Ramsey Equation: r = \delta + \eta g, where r denotes the interest rate, \delta represents the pure time preference rate, \eta signifies the elasticity of marginal utility, and g indicates the growth rate of consumption. This equation forms the basis for understanding how economic benefits and costs are treated over time.

Contrasting Economic Analyses

• Gradualism vs. Urgency: Many proponents of traditional economic analyses suggest a gradual reduction in emissions, emphasizing a more conservative approach to climate policy. In sharp contrast, Stern’s analysis advocates for a sense of immediacy and the implementation of far-reaching measures to address greenhouse gas emissions without delay.

• Key Assumptions and Parameters: The review employs a base-case coefficient of risk aversion (the degree to which individuals prefer certainty over uncertainty) set at \eta = 1 and a near-zero rate of pure time preference (\delta \approx 0). These assumptions conflict with observed market behaviors, wherein discount rates are typically much higher than those used in the review.

Significant Points of Contention

• Discount Rate Issues: One of the critical challenges highlighted is that low discount rates significantly affect the perceived value of future benefits and costs. Critics argue that this approach does not align with mainstream economic behaviors, which traditionally favor higher discount rates.

• Uncertainty in Climate Change Predictions: The Stern Review emphasizes the uncertainty surrounding the predicted effects of climate change and the necessity of