Stern - 2008

American Economic Association
The Economics of Climate Change

Author(s): Nicholas Stern
Source: The American Economic Review, Vol. 98, No. 2, Papers and Proceedings of the One
Hundred Twentieth Annual Meeting of the American Economic Association (May, 2008),
pp. 1-37
Published by: American Economic Association
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American Economic Review: Papers & Proceedings 2008, 98:2,1-37
http://www.aeaweb.Org/articles.php7doi-l0.l257/aer.98.2.l
RICHARD T. ELY LECTURE
The Economics of Climate Change
By Nicholas Stern*
Greenhouse gas (GHG) emissions are exter? quickly as possible, because policy decisions are
nalities and represent the biggest market failure both urgent and moving quickly?particularly
the world has seen. We all produce emissions, following the recent United Nations Framework
people around the world are already suffering Convention on Climate Change (UNFCCC)
from past emissions, and current emissions will meetings in Bali in December 2007. The rel?
have potentially catastrophic impacts in the evant decisions can be greatly improved if we
future. Thus, these emissions are not ordinary, bring the best economic analyses and judge?
localized externalities. Risk on a global scale ments to the table in real time.
is at the core of the issue. These basic features A brief description of the scientific processes
of the problem must shape the economic analy? linking climate change to GHG emissions will
sis we bring to bear; failure to do this will, and help us to understand how they should shape the
has, produced approaches to policy that are pro? economic analysis. First, people, through their
foundly misleading and indeed dangerous. consumption and production decisions, emit
The purpose of this lecture is to set out what GHGs. Carbon dioxide is especially important,
I think is an appropriate way to examine the accounting for around three-quarters of the
economics of climate change, given the unique human-generated global warming effect; other
scientific and economic challenges posed, and relevant GHGs include methane, nitrous oxide,
to suggest implications for emissions targets, and hydrofluorocarbons (HFCs). Second, these
policy instruments, and global action. The sub? flows accumulate into stocks of GHGs in the
ject is complex and very wide-ranging. It is a atmosphere. It is overall stocks of GHGs that
subject of vital importance but one in which the matter, and not their place of origin. The rate
economics is fairly young. A central challenge at which stock accumulation occurs depends on
is to provide the economic tools necessary as the "carbon cycle," including the earth's absorp?
tive capabilities and other feedback effects.
* London School of Economics and Political Science, Third, the stock of GHGs in the atmosphere
Houghton Street, London WC2A 2AE, UK (e-mail: traps heat and results in global warming: how
n.stern@lse.ac.uk). I am very grateful for the advice and
comments of Claire Abeille, Dennis Anderson, Alex much depends on "climate sensitivity." Fourth,
Bowen, Sebastian Catovsky, Peter Diamond, Simon Dietz, the process of global warming results in climate
Ottmar Edenhofer, Sam Fankhauser, Graham Floater, Su change. Fifth, climate change affects people,
Lin Garbett, Ross Garnaut, Roger Guesnerie, Geoffrey species, and plants in a variety of complex ways,
Heal, Daniel Hawellek, Claude Henry, Cameron Hepburn,
Paul Joskow, Jean-Pierre Landau, James Mirrlees, Ernesto
most notably via water in some shape or form:
Moniz, Steven Pacala, Nicola Patmore, Vicky Pope, Laura storms, floods, droughts, sea-level rise. These
Ralston, Mattia Romani, John Schellnhuber, Matthew changes will potentially transform the physical
Skellern, Robert Socolow, Martin Weitzman, Dimitri and human geography of the planet, affecting
Zenghelis, and all of those who worked on and guided the where and how we live our lives. Each of these
Stern Review team. The views expressed here are mine and
do not necessarily reflect the judgements or positions of
five links involves considerable uncertainty. The
those who kindly provided advice, or of the London School absorption-stock accumulation, climate-sen?
of Economics, or of the UK Government, for whom I was sitivity, and warming-climate change links all
working while leading the Stern Review on the Economics involve time lags.
of Climate Change. This is dedicated to my close friend,
distinctive and distinguished economist and fine man,
The key issues in terms of impacts are not
Andrew Glyn, who died on December 22, 2007, and whose simply or mainly about global warming as
funeral took place in Oxford, UK, on the same day as the such?they concern climate change more
Ely Lecture, January 4, 2008. broadly. Understanding these changes requires
1
2 AEA PAPERS AND PROCEEDINGS MAY 2008
specific analysis of how climate will be affected is different from our usual examples in four key
regionally. Levels and variabilities of rain? ways: (a) it is global in its origins and impacts;
fall depend on the functioning of weather and (b) some of the effects are very long term and
climate for the world as a whole. As discussed governed by a flow-stock process; (c) there is
below, temperature increases of 4-5?C on aver? a great deal of uncertainty in most steps of the
age for the world would involve radical and scientific chain; and (d) the effects are potentially
dangerous changes for the whole planet, with very large and many may be irreversible. Thus,
widely differing, often extreme, local impacts. it follows that the economic analysis must place
Further, the challenge, in large measure, is one at its core: (i) the economics of risk and uncer?
of dealing with the consequences of change tainty; (ii) the links between economics and eth?
and not only of comparing long-run equilibria. ics (there are major potential policy trade-offs
Under business as usual (BAU), over the next both within and between generations), as well as
two centuries we are likely to see change at a notions of responsibilities and rights in relation
rate that is fast-forward in historical time and to others and the environment; and (iii) the role
on a scale that the world has not seen for tens of of international economic policy. Further, the
millions of years. potential magnitude of impacts means that, for
This very brief and oversimplified descrip? much of the analysis, we have to compare strate?
tion of the science carries key lessons for eco? gies that can have radically different develop?
nomics. The scientific evidence on the potential ment paths for the world. We cannot, therefore,
risks is now overwhelming, as demonstrated in rely only on the methods of marginal analysis.
the recent Intergoverrnmental Panel on Climate Here, I attempt to sketch briefly an analysis that
Change (IPCC) Fourth Assessment Report, or brings these three parts of economics to center
AR4 (IPCC 2007). Like most of those here today, stage. It is rather surprising, indeed worrying,
I am not a climate scientist. As economists, our that much previous analysis of practical policy
task is to take the science, particularly its analy? has relegated some or all of these three key
sis of risks, and think about its implications for pieces of economics to the sidelines.
policy. Only by taking the extraordinary posi?
tion that the scientific evidence shows that the The Structure of the Argument.?The struc?
risks are definitely negligible should econo? ture of the argument on stabilization is crucial,
mists advocate doing nothing now. The science and we begin by setting that out before going
clearly shows that the probability and frequency into analytical detail. The choice of a stabili?
of floods, storms, droughts, and so on, is likely zation target shapes much of the rest of policy
to continue to grow with cumulative emissions, analysis and discussion, because it carries strong
and that the magnitude of some of these impacts implications for the permissible flow of emis?
could be catastrophic. sions, and thus for emissions reductions targets.
While an understanding of the greenhouse The reduction targets, in turn, shape the pricing
effect dates from the nineteenth century,1 in and technology policies.
the last decade, and particularly in the last few Understanding the risks from different strate?
years, the science has fortunately started to give gies is basic to an understanding of policy. Many
us greater guidance on some of the possible articulated policies for risk reduction work in
probability distributions linking emissions and terms of targets, usually expressed in terms of
stocks to possible warming and climate change, emission flows, stabilization levels, or average
thus allowing us to bring to the table analytical temperature increases. The last of these has
tools on economic policy toward risk. the advantage that it is (apparently) easier for
The brief description of the science above tells the general public to understand. The problem
us that GHG emissions are an externality which is that this apparent ease conceals crucial ele?
ments that matter greatly to social and economic
outcomes?it is the effects on storms, floods,
1 Joseph Fourier recognized in the 1820s (Fourier 1827) droughts, and sea-level rise that are of particular
that the atmosphere was trapping heat; three decades later,
importance, and a heavy focus on temperature
John Tyndall (1861) identified the types of gases responsi?
ble for the trapping; and at the end of the century, Svante can obscure this. Further, and crucially, tem?
Arrhenius (1896) gave calculations of the possible effects perature outcomes are highly stochastic and
of doubling GHGs. cannot be targeted directly. Emissions can be
VOL. 98 NO. 2 RICHARD T. ELY LECTURE 3
more easily controlled by policy. However,

most it is
important in my view, it can help to
the stocks that shape the warming. Thus,
key there
trade-offs and the overall logic and
are arguments for and against each ofments of an argument.
the three
dimensions. We shall opt for stock targets,
A usefulon analogy is the role of Com
General Equilibrium Models (CGMs) in
the basis that they are closest to the phenomenon
that drives climate change and the most sions of trade policy. These have much
easily
expressed in one number. robust foundations than aggregative mod
An alternative focus for policy is the price
the economics of climate change, yet thei
of GHGs rather than quantities. In a titative
perfectly
results are very sensitive to assum
understood nonstochastic world, standard
and dual?
they leave out so much that is impor
ity theory says that price and quantitypolicy. Thus, most economists would n
tools are
essentially mirror images and can be used
vate inter?
them to the main plank of an argum
changeably. However, where risk and uncer?
trade policy. That policy would usually b
tainty are important and knowledgeter
is highly
founded on an understanding of ec
theory
imperfect, we have to consider the relative and of economic history, togethe
merits
of each. For the most part, we ignore thecountry studies and particular studies
differ?
ence between risk and uncertainty here (whereand issues in question.
context
However,
the latter is used strictly in the Knightian sense as the Stern Review stresse
analysis
of unknown probabilities), but it is a very impor?has very serious weaknesses an
tant issue (Claude Henry 2006; Stern 2007,
not 38
be taken too literally. It is generally
to aggregate into a single good, and in so
39) and a key topic for further research.
misses
We begin by setting out some of the a great deal of the crucial de
major
risks from climate change, and argue thatimpacts?on
these different dimensions and in
risks point to the need for both stockent andlocations?which
flow should guide risk
targets, guided by an assessment of sis. theItcosts
is forced to make assumptions abou
involved in achieving them. Long-termand structures of growth over many cen
stabiliza?
tion (or stock) targets are associated with a range
Further, it will be sensitive to the specif
of ethical
of potential flow paths, although the stock target frameworks and parameters. T
exerts a very powerful influence on theirestimates
shape. of marginal social costs of d
The choice of a particular flow pathprovide
would a bevery weak foundation for polic
influenced by the expected pattern of costs
type ofovermodelling does have an importan
time. The target flow paths can then be associ?
plementary place in an analysis, but all to
ated with a path for marginal costs of abatement,
it has been applied naively and transform
if we think of efficient policy designed theto keep plank of an argument.
central
flows to the levels on the path, in particular by
Our analysis of risks and targets points
need abate?
using a price for carbon set at the marginal for aggregate GHG stabilization targ
ment cost (MAC). Essentially, the economics
below 550 ofparts per million (ppm) carbon
ide
risk points to the need for stock and flow equivalent (C02e), arguably substa
quantity
targets and the economics of costs and below.
efficiency
This corresponds to cuts in global
to a price mechanism to achieve the targets.
sions flows of at least 30 percent, and pr
A policy that tries to start with a around
price for
50 percent, by 2050. These cut
marginal GHG damages has two major prob?
seem large in the context of (we hope) a g
world economy,
lems: (a) the price estimate is highly sensitive to but are not ambitious in r
ethical and structural assumptions on the to future;
the risks we run by exceeding 550ppm
And,higher
and (b) there is a risk of major losses from given the avoided risks, the costs of
stocks than anticipated, since the damages1 percent
rise of world GDP per annum (see S
IB below) of achieving this stabilization
steeply with stocks and many are irreversible.
Formal modelling of damages can be supple?
regarded as relatively low. The carbo
ment the argument in three ways. First, it can
required to achieve these reductions (up t
provide indicative estimates of overall 2030)
damageswould be around, or in excess of, $
tonofC02.
to guide strategic risk analysis. Second, it can
provide estimates of marginal damageThis costs of incorporates many importan
paper
GHGs, for comparison with MACs. Third, ments of andthe Stern Review, published on t
in October/November 2006 (see http://www. can be run many times for different possible
sternreview.org.uk, including Postscript) and parameter choices. Such exercises yield Monte
in book form (Stern 2007) a year ago, but goes Carlo estimates of probability distributions of
beyond it in many important ways?in relation outcomes. A discussion of various methods and
to subsequent policy discussions, new evidence models may be found in Malte Meinshausen
and analysis, and discussions in the economics (2006) and in Chapter 1 of the Stern Review.
literature. Figure 1 and Table 1 are drawn from the mod?
There are four further parts to this paper. The els of the UK's Hadley Centre. The work of the
second part focuses on risks and how to reduce Hadley Center was a particular focus of models
them, and on costs of abatement. The third part for the Stern Review for a number of reasons.
examines formal modelling and damage assess? First, it is one of the world's finest climate sci?
ment. The fourth part examines policy, and in ence groups, with a very large computing capac?
particular the role of different policy instru? ity. Second, it was close by and the staff were
ments. The final part outlines what I see as the extremely accessible and helpful. Third, its
central elements of a global deal or framework probability distributions are fairly cautious, bal?
for collaborative policy and discusses how that anced, and "middle of the road" (Meinshausen
deal can be built and sustained. 2006); this judgement is sustained by a com?
parison of their results with the subsequently
I. Stabilization of Stocks of Greenhouse Gases I: published AR4 (IPCC 2007).
Risks and Costs Figure 1 and Table 1 present estimated proba?
bilities for eventual temperature increases (which
A. Risks and Targets take time to be established) relative to preindus
trial times (around 1850), were the world to sta?
The relation between the stock of GHGs in bilize at the given concentration of GHGs in the
the atmosphere and the resulting temperature atmosphere measured in ppm C02e. Figure 1
increase is at the heart of any risk analysis. The portrays 90 percent confidence intervals?
preceding link in the chain, the way the carbon the solid horizontal bars?for temperature
cycle governs the process relating emissions increases. The lower bound (fifth percentile)
to changes in stocks, and the subsequent link, is derived from the IPCC Third Assessment
from global average temperature to regional and Report, or TAR (Tom Wigley and Sarah Raper
local climate change, are full of risk as well. But 2001; IPCC 2001a, b)3 and the upper bound is
the stock-temperature relationship is the clear? from the Hadley Center (Hadley Center 2005;
est way to begin, as it anchors everything else. James M. Murphy et al. 2004). The dotted bars
Broadly conceived, it is about "climate sensitiv? cover the range of the 11 studies examined by
ity"?in terms of modelling, this is indicated Meinshausen (2006). The bar for 550ppm C02e
by the expected eventual temperature increase (with a 90 percent interval of 1.5?C to 5.3?C)
from a doubling of GHG stocks.2 approximately represents the possible range for
There are now a number of general circula? "climate sensitivity."
tion models (GCMs?also known as global cli? Concentrations are currently around 430ppm
mate models) that have been built to describe C02e (Stern Review, Figure 1.1 (Stern 2007,
the links from emissions to climate change. 5)?Kyoto GHGs), and are rising at around
The large ones work with a very large number 2.5ppm C02e per annum. This rate appears to be
of geographic cells, consume computer time accelerating, particularly as a result of the very
extremely heavily, and can be run only on some rapid growth of emissions in China. On fairly
of the world's biggest computers. Nevertheless, conservative estimates (International Energy
particularly if combined with appropriate link?
ing to a large number of other machines, they
3 The TAR was without probabilities but Wigley and
Raper produced distributions based on it. The Stern Review
2 Climate modellers tend to define "doubling" in rela? blended the TAR and Hadley because the former was
tion to preindustrial times. The relationship from stock to based on international discussion, but the latter was more
temperature increase is approximately logarithmic, so that recent. The Stern Review used lower climate sensitivities
doubling from other stock levels would be likely to yield a than Hadley, although the IPCC's more recent AR4 (IPCC
similar increase. 2007) is closer to those used by Hadley.
95%
5% 400ppnJCO2e
490ppmCO2e
550ppmCO?e
esoppm ico*
?*_ ?
:
*--M
750ppmCC|?e
Eventual temperature change (relative to prelnduatrial)
Figure 1. Stabilization and Eventual Change in Temperature
Source: Stern Review, Table 1.1 (Stern 2007, 16); Meinshausen 2006; Wigley and Raper
2001; Murphy et al. 2004.
Table 1?Likelihood (in percentage) of Exceeding a Temperature Increase

at Equilibrium
Stabilization level
(in ppm C02e) 2?C 3?C 4?C 5?C 6?C 7?C
450 78 18 3 1 0 0
500 96 44 11 3 1 0
550 99 69 24 7 2 1
650 100 94 58 24 9 4
750 100 99 82 47 22 9
Source: Stern Review Box 8.1 (Stern 2007, 220) with some added information.
Agency (IEA) 2007), China's energy-related

The issue is still more worrying than that of
emissions are likely to double by 2030, taking
dealing with very large damages with very lo
overall emissions from 6-7 to 12-15 gigatons
probability.
(Gt). There seems little doubt that, under BAU,Further, we should emphasize that key posi?
the annual increments to stocks would averagetive feedback from the carbon cycle?such as
somewhere well above 3ppm C02e, perhaps 4 of methane from the permafrost, the
release
or more, over the next century. That is likelycollapse
to of the Amazon, and thus the destruc?
take us to around, or well beyond, 750ppm C02e tion of a key carbon sink, and reduction in
by the end of the century. If we manage to sta?the absorptive capacity of the oceans?has
bilize there, that would give us around a 50-50
been omitted from the projected concentration
chance of a stabilization temperature increaseincreases quoted here. It is possible that stocks
could become even harder to stabilize than this
above 5?C. This is a high probability of a disas?
description suggests.
trous transformation of the planet (see below).4
4 To avoid excessive length of discussion, we focus on

5?C, because it is an extremely dangerous increase and
because its probability of occurrence under BAU is far from full range of possible concentrations and associated prob?
small. In a full analysis, one could and should look at the ability distributions for temperature increases.
We do not really know what the world would from "cross-sectional" (Robert Mendelsohn
look like at 5?C above preindustrial times. The et al. 2000, 557) comparisons of regions with
most recent warm period was around 3 million current temperature differences of around
years ago when the world experienced tempera? 5?C?comparisons between, say, Massachusetts
tures 2-3?C higher than today (Eystein Jansen and Florida miss the point. Nor, given the non
et al. 2007, 440). Humans (dating from around linearities involved, can we extrapolate from
100,000 years or so) have not experienced any? lower temperature increases (say 2?C) concern?
thing that high. Around 10,000-12,000 years ing which there is more evidence. Most people
ago, temperatures were around 5?C lower than contemplating 5?C increases and upward would
today, and ice sheets came down to latitudes just surely attach a very substantial weight on keep?
north of London and just south of New York. ing the probability of such outcomes down.
As the ice melted and sea levels rose, England From this perspective, an examination of
separated from the continent, rerouting much of Table 1 suggests that 550ppm C02e is an upper
the river flow. These magnitudes of temperature limit to the stabilization levels that should be
changes transform the planet. contemplated. This level is nevertheless rather
At an increase of 5?C, most of the world's ice dangerous, with a 7 percent probability of being
and snow would disappear, including major ice above 5?C and a 24 percent probability of being
sheets and, probably, the snows and glaciers of above 4?C. The move to 650ppm C02e gives
the Himalayas. This would eventually lead to a leap in probability of being above 4?C to 58
sea-level rises of 10 meters or more, and would percent, and of being above 5?C to 24 percent.
thoroughly disrupt the flows of the major rivers Further, we should remember that the Hadley
from the Himalayas, which serve countries com? Center probabilities are moderately conserva?
prising around half of the world's population. tive?one highly computationally intensive
There would be severe torrents in the rainy sea? Monte Carlo estimate of climate sensitivity
son and dry rivers in the dry season. The world found a 4.2 percent probability of temperatures
would probably lose more than half its species. exceeding 8?C (David Stainforth et al. 2005). A
Storms, floods, and droughts would probably be concentration in the region of 550ppm C02e is
much more intense than they are today. clearly itself a fairly dangerous place to be and
Further tipping points could be passed, which the danger posed by even higher concentrations
together with accentuated positive feedbacks looks unambiguously unacceptable. For this
could lead to "runaway" further temperature reason, I find it remarkable that some econo?
increase. The last time temperature was in the mists continue to argue that stabilization levels
region of 5?C above preindustrial times was in around 650ppm C02e or even higher are pref?
the Eocene period around 35-55 million years erable to 550ppm, or even optimal (William D.
ago. Swampy forests covered much of the world Nordhaus 2007a, 166; Mendelsohn 2007, 95). It
and there were alligators near the North Pole. is important to be clear that the "climate policy
Such changes would fundamentally alter where ramp" (Nordhaus 2007b, 687) advocated by
and how different species, including humans, some economists involves a real possibility of
could live. Human life would probably become devastating climatic changes.
difficult or impossible in many regions that are In thinking about targets for stabilization,
currently heavily populated, thus necessitating we have to think about more than the even?
large population movements, possibly or prob? tual stocks. We must also consider where we
ably on a huge scale. History tells us that large start; costs of stabilization; and possibilities of
movements of population often bring major con? reversal, or backing out, if we subsequently find
flict. And many of the changes would take place ourselves in or approaching very dangerous ter?
over 100-200 years rather than thousands or ritory. The costs of stabilization depend strongly
millions of years. on where we start. Starting at 430ppm C02e, sta?
While there is no way that we can be precise bilizing at 550ppm C02e or below would likely
about the magnitude of the effects associated cost around 1 percent of world GDP with good
with temperature increases of this size, it does policy and timely decision making (see Section
seem reasonable to suppose that they would, IB); for stabilization at 450ppm C02e, it might
in all likelihood, be disastrous. We cannot cost 3 or 4 times as much (possibly more). With
obtain plausible predictions by extrapolating bad policy, costs could be still higher. Note that
B. Costs
the comparison of costs between 450ppm andof Abatement and Prices of G
550ppm C02e illustrates the cost of delay5?
Towould
waiting for 30 years before strong action this point, our discussion of targ
take us to around 530ppm C02e, from focused on those for the stabilization of
which
point the cost of stabilizing at 550ppm We mustC02enow ask about implications fo
would likely be similar to stabilizing sions paths and how much, with good
at 450ppm
they would cost. We have already anti
C02e starting from now. Under most reasonable
assumptions on growth and discounting, part of the broad answer?around 1 per
a flow
of 1 percent of GDP for 50-100 years world GDP per annum to get below
starting
now would be seen as much less costly C02e?but
than awe must look at the argume
flow for a similar period of 4 percent little
or so more
of detail.
GDP, starting 30 years later. Figure 2 illustrates possible paths for
It can be argued that, at some future lization
point, at 550ppm C02e (thin line), 5
C02e (dotted)
we might be able to turn to geoengineering, for and 450ppm C02e (dot-d
the solidtoline is BAU. There are many pa
example, firing particles into the atmosphere
keep out solar energy, analogous to thestabilization
effect of at a given level?see, for ex
Sternare,
major volcanic eruptions in the past. There Review Figure 8.2 (Stern 2007, 2
however, substantial dangers associated all of with
them are a similar shape to those sh
initiating other effects we do not understand.
a path peaks later it has to fall faster). An
We might well be replacing one severe carbon
risk with cycle weakens, the cuts would hav
another; however, extreme circumstances could
larger to achieve stabilization at a give
require an extreme response. And there see Stern
are dif? Review Figure 8.1 (Stern 200
ficult issues of global governance?would Broadly it be
speaking, however, a path stabili
550ppm C02e
right for just one country, or group of countries, to or below will have to show
do this? It seems much more sensible, sions peaking in the next 20 years. Fo
at accept?
stabilization levels, the peak will have
able cost, to avoid getting into this position.
The above is basically the risk-management
sooner. The magnitudes of the implied
economics of climate change. For antions expendi?
between 2000 and 2050 are around
ture of around 1 percent (between -1 centpercent
for 550ppm C02e, 50 percent for
and 3 percent) of world GDP (see Section C02e, IB),
and 70 percent for 450ppm C02
we could keep concentration levels well below
relative to BAU are indicated in the figur
550ppm C02e and ideally below 500ppm C02e.
Figure 3 shows that, to achieve these
While leaving the world vulnerable, this emissions,
would it will be necessary to take
avoid the reckless risks implied by the acrosshigher
the board and not in just two or th
stabilization concentrations (e.g., 650ppm
torsC02e)
such as power and transport. For th
advocated by some economists. Thinking as aabout
whole, energy emissions represent
the information basis for this argument two-thirdsalso of the total, and nonenergy a
one-third.
points to caution. If (as is unlikely) the risks of Land use change, mainly def
high concentrations turn out to be lowtion and and
we degradation of forests, accou
have taken action, we would still have nearly
purchased 20 percent of the total. Given t
a cleaner, more biodiverse, and more attractive
world economy is likely to be perhaps
world, at modest cost. If our actionstimes are weak
bigger in mid-century than it is now
and the central scientific estimates arelutecorrect,
cuts of around 50 percent would
we will be in very dangerous circumstances
cuts of 80-85 percent in emissions per
output.
from which it may be impossible, or very Further, since emissions from so
costly,
to recover. tors (in particular agriculture) will be diff
cut back to anything like this extent, an
richer countries should make much bigge
portional reductions than poor countr
Section IV), richer countries will need
5 There would be some negatives (moreclose-to-zero
inflexible emissions in power (electric
transport
equipment in place) and some positives (more technical by 2050. Close-to-zero emiss
knowledge). power are indeed possible and this would
100
10 ^ - ? -,^.^^70gg?Mr;-;?
-v
2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
Figure 2. BAU and Stabilization Trajectories for 450-550ppm C02e
Source: Stern Review. Figure 8.4 (Stern 2007, 233).
ENERGY
EMISSIONS Industry (14%)
Other energy
related (5%)
Waste (3%)
Agriculture
Transport (14%)
(14%)
NONENERGY
EMISSIONS
(8%) Land use
(18%)
Total emissions in 2000:42 GtCO,e
Figure 3. Reducing Emissions Requires Action across Many Sectors
Source: Stern 2007, 196.
close-to-zero emissions for much of transport. way of life to the extent of that brought by elec?
This would, however, require radical changes tricity, rail, automobiles, or the Internet.
to the source and use of energy, including much On the path for stabilization there would
greater energy efficiency. Achieving the neces? be different options for cutting emissions that
sary reductions would also require an end to would be more prominent at different times. In
deforestation. The totality of such reductions the earlier periods, there would be greater scope
would, however, not result in a radical change in for energy efficiency and halting deforestation,
social
and with technical progress there will be, andcost of carbon (SCC) reflecting
future damage of an incremental emission. T
already are, strong roles for different technolo?
gies in power and transport. levels quoted here for the MAC are consis
Various different options for abatement with ranges for the SCC indicated in the S
were
Review along an abatement path for 550p
discussed in Chapter 9 of the Stern Review.6
McKinsey has recently carried out C02e stabilization.
a more
However, the SCC is very slippery num
detailed study (Per-Anders Enkvist, Tomas
Naucl?r, and Jerker Rosander 2007)?see cally since it is so sensitive to assumptio
Figure
about
4. There are several important lessons from thismodel structure, including future em
sion
type of curve. First, there are many options paths, carbon cycles, climate sensitiv
for
future
reducing emissions that have negative cost; that technologies, and ethical approache
is, they save money. Second, there is avaluation
whole over the centuries to come. The
at time
range of options and each should be explored in t is the expectation of the integral9 o
detail?for example, the costs associated from
witht onward of:
combating deforestation in the McKinsey curve
are, in my view, far too high.7 Third, the?emis?
the marginal social utility of consumption
r (embodying ethical values and a partic
sions savings from any one option will depend
path)
on what it replaces. Fourth, given the broad
range of options, policy is very important?bad
X the impact on consumption at r of all rel?
policy will lead to the uptake of more expensive
evant preceding temperature changes (and
options. Fifth, technical progress will be impor?
tant and should be promoted so that the range resultant climate change)
of options is widened and costs are reduced.
Finally, and of special importance, startingXnow
the impact on a relevant temperature
increase of increases in preceding carbon
in a strong way and with clear signals will allow
more time for planned choices, discovery stocks
of
options, and exploration of the renewal periods
X the impact on all relevant stocks of an
and timings for equipment. This is the meas?
increase in carbon emissions at t, where
ured, lower-cost approach. Going more slowly
and then moving in haste when and if the sci? "impact" in the above is to be interpreted
ence is confirmed still more strongly, is likelyas to
a partial derivative.
be the expensive option.
Very importantly for policy, this type ofGiven
fig?this sensitivity, it is remarkable how
carelessly the SCC is often quoted?it is quite
ure gives us an understanding of where carbon
prices (or GHG prices more generally)common,
shouldfor example, for people to quote an
SCC
be. By 2030, cuts at the world level would without even referring to a reference emis?
have
to be of the order of 20 Gt C02e (see Figure
sions 2)
path, to say nothing of all the other rel?
evant assumptions that matter greatly.
for stabilization at 550ppm C02e. This suggests
a C02 price of around ?30 per ton.8 Thus, the SCC is a very weak foundation for
A fairly clear idea of where the carbonpolicy.
priceThe target approach and the calculation
of the associated MAC is more attractive from
should be from the point of view of necessary
the point of view both of policy toward risk and
abatement is of great help both to policymakers
of clarity of conclusions. It is also important,
and to investors. It also provides the opportu?
however, to check prices derived from the MAC
nity to check against estimates of the marginal
against SCC calculations and to keep policy
under revision, as further information and dis?
6 Illustrative MAC curves were provided in the Stern covery arrives. Some notion of the SCC is also
Review, Figures 9.1 (Stern 2007, 243) and 9.2 (Stern 2007, useful in examining the emissions savings from,
249).
7 Erin C. Myers (2007, 9-12) reviews the literature and
highlights the outlier status of the McKinsey deforestation
estimate; see also the discussion in Section IV. 9 This sketch of the calculation assumes the simple
8 This is not the place to speculate about euro-dollar objective of the maximization of the integral of expected
exchange rates over two or three decades. utility.
10 AEA PAPERS AND PROCEEDINGS MA Y 2008
203
Coal-to- Avoid
Cost of abatement COS; ?a?*?
EUR/tOQ*
* -27QtonCQ,ebelow40EUfVton(-46%vs.
BAU)
* -7 Gton of negative and zero cost opportunities
* Fragmentation of opportunities
Figure 4. McKinsey Bottom-Up Approach to Abatement Costs
Source: Enkvist et al. 2007, 38.
for example, transport programs or policies. If The Stern Review (Chapter 10) also looked
the MAC and SCC were thought to be in very at top-down macro modelling of costs of
different ball parks for an anticipated path, it emissions reductions (see also Terry Barker,
would suggest strongly that policy revision is Mahvash Saeed Qureshi, and Jonathan K?hler
necessary. 2006). Both the bottom-up (Chapter 9) and
Prices for abatement should be at a level that the top-down (Chapter 10) studies produced
supports carbon capture and storage (CCS) for numbers in similar ranges?around 1 percent
coal. Without CCS for coal it will be difficult of world GDP. There is, of course, consider?
(and more costly) to achieve the necessary cuts, able uncertainty. Bad policy or delayed deci?
given that many countries will rely heavily on sions could give higher numbers. Stronger
coal for power generation for the next 30 or technical progress could give lower numbers.
40 years (IEA 2006; 2007). China and India Assumptions about substitutability between dif?
(Expert Committee on Integrated Energy Policy ferent goods and options matter, too. Since the
(ECIEP) 2006), for example, will be using coal Stern Review was published, there have been
for around 80 percent of their electricity plants a number of new studies, both bottom-up and
for the next 30 years or so?for the simple rea? top-down. Significant examples of the former
sons that coal is cheap and available within their are those from McKinsey (Enkvist, Naucl?r,
own borders; that they are familiar with the and Rosander 2007) and the IEA (2007), both
technologies; and that the plants can be erected of which indicated costs either in the region we
quickly. Speed is of great importance for them, suggested, or somewhat lower. Similar conclu?
as the costs of electricity outages are very high. sions are drawn in the AR4 (IPCC 2007).
VOL. 98 NO. 2 RICHARD T ELY LECTURE 11
It is very important to recognize reduce emissions, and thus risks. Th

that costs
of 1 percent of GDP do not necessarily slow
kind of judgement that people take wh
medium- or long-term growth rates. They are
sidering various forms of insurance, or
like a one-off 1 percent increase in prices from or infrastructure, or new m
of buildings
"doing energy" in different ways. Further, there
treatments. They try to be as clear as
is a real possibility that incentives on
to discov?
consequences and costs, bearing in
ery could generate a Schumpeterianthat both
burst ofare stochastic and that risk is
growth?on such possibilities see recent work
essence, while also being aware that it w
bemarkets
by Philippe Aghion (2007). The scale of difficult to put a price or money v
for new technologies will be very consequences
large (IEA and risks.
2006); see also Samuel Fankhauser, ItFriedel
is also informative, however, to try
Sehlleier, and Stern (2007) for an assessment
duce, using aggregate models, quantitati
of investment and employment opportunities,
mates of avoided damages in order to
which are likely to be positive.10 with costs. For climate change, that q
Finally, reducing GHGs can bring strong
cation may be possible for some dime
benefits elsewhere. Cleaner energy can provide
for some locations, for some time perio
for some
greater energy security and energy access. It canranges of temperature incr
give reductions in local air pollution. Cleanerthe avoidance of planet-tran
However,
transport policies can increase life expectancy.
ing change by keeping down risks of
Combating deforestation can protect watersheds,
above is at the heart of the argument he
sustain biodiversity, and promote local liveli?
is extremely difficult to provide plausibl
hoods. Taking these associated benefits into
gate numbers for the effects and overal
account would reduce cost estimates further.
ages of temperatures so far out of exper
In summary, looking back after a year, we when nonlinearities may be o
particularly
would suggest that subsequent evidence and
importance. Nevertheless, formal model
central
analysis have confirmed the range of to the tools of our trade and the e
our cost
estimates for stabilization, or indicated
dothat
havethey
value in bringing out the logic o
may be on the high side. Good policy and timelytrade-offs.
important
decision making are, however, crucial to Inkeep?
making valuations of consequenc
ing costs down. And we would emphasize have tothatface very difficult analytical and
issues. goal
taking a clear view now of a stabilization How does one value the transform
allows for a measured and careful adjustment,
the planet, the consequences of radical c
allowing for the replacement cyclesin ofways
capital
of life, and big movements of po
goods. To wait and see, or to rely on andaassociated
"cli? conflict? Our standard cos
mate policy ramp," risks not only excessive and
efit analysis (CBA) tools do not give u
dangerous levels of stocks but also much more
guidance. I have invested a lot of effo
Jean
costly abatement if, as is likely, there P. Dr?ze and Stern 1987, 1990),
is a sub?
sequent realization that the response manyhas others,
been in developing these tools, a
delayed and inadequate. some understanding of what they are and
they can be applied. They are largely ma
II. Stabilization of Stocks of methods, providing tools for analysis
Greenhouse Gases II: changes in, say, one or two markets as a
Modelling and Evaluation of Damages
a program. But when we are considering
strategic decisions for the world as a who
A. Introduction huge dynamic uncertainties and feedback
potential contribution of an approach to
The previous section looked directly at the
making based on marginal methods is ver
risks from GHGs, and at the costs of ited.
action to
Rational decision making has to
to the first principles from which the m
10 These assessments refer to the potential shifts of

the demand side of labor markets?outcomes depend, of example, Chapters 1, 3, 4 and 5 of t
11 See, for
course, on market structures. Review.
methods of CBA are derived. This is not at all Let us start with the definition of a discount
to use a different theory. On the contrary, it is to rate in policy evaluations. It is simply the propor?
maintain the theory and to avoid a gross misap? tionate rate of fall of the value of the numeraire
plication of the special (i.e., marginal) case. used in the policy evaluation. In the simple case,
The centrality of nonmarginal changes and with aggregate consumption as the numeraire,
of risk means either using the risk-analysis we have a social discount factor or SDF, ?(t),
approach of Section IA, or using aggregate mod? which measures the social value of a unit of con?
elling with a social welfare function to compare sumption at time t relative to a unit at time zero.
consequences. Both have their role, but for the The social discount rate, or SDR, is then -?/?.
reasons given I would see the former as the main A number of general conclusions follow
plank of the argument. The latter has a valuable immediately from these basic definitions. First,
supplementary role which we now investigate. the SDF and the SDR depend on a given refer?
In setting out a social welfare function to ence path for future growth in consumption and
evaluate damages and costs, the valuation of will be different for different paths. Second, the
consequences on different dimensions?social, discount rate will vary over time. Third, with
health, conflict, and so on?will be extremely uncertainty, there will be a different discount
difficult. I do not go into these issues. I focus rate for each possible sequence of outcomes.
on one issue that has, understandably, received Fourth, there will be a different discount rate
considerable attention in discussion of the Stern for different choices of numeraire. In imperfect
Review?how to value benefits accruing to dif? economies, the social value of a unit of private
ferent people at different times. There are una? consumption may be different from the social
voidable ethical issues. They are the subject of value of a unit of private investment, which may
Section IIB. In Section IIC we examine some of be different from the social value of a unit of
the challenges, results, and sensitivities of for? public investment. And the rates of changes of
mal modelling, and comment on new evidence these values may be different too.
and discussions concerning the Stern Review's A further key element for understanding dis?
damage estimates after one year. count rates is the notion of optimality of invest?
ments and decisions. For each capital good, if
B. Ethics resources can be allocated without constraint
between consuming the good in question and its
Discounting.?Much of the discussion of use in accumulation, we have, for that good, the
ethics in relation to the Stern Review has been result that the social rate of return on investment
focused on discounting. Sometimes, simplistic (the marginal productivity of this type of good
approaches to discounting conceal or obscure at shadow prices), the SRI, should be equal to
the underlying structural and ethical logic by the SDR in terms of that good (i.e., with that
shoehorning the issues into a simple discount good as numeraire). This is intuitively clear and
rate specified entirely externally to the problem. in optimal growth theory is a standard first
However, careful use of theory and concepts is order condition. But where there are constraints
crucial. Some have argued that "the discount on this optimization, as there usually will be
rate of the Stern model" is too low in relation to in imperfect economies, this condition that the
market rates of return. This argument has gener? SRI equal the SDR is not generally applicable.
ally been thoroughly confused for a whole set of Dr?ze and Stern (1987, 1990), for example, show
reasons. It arises from inappropriate application how opportunity costs, and thus shadow prices
of a marginal method to a strongly nonmarginal and shadow rates of return, depend on which
context, failure to apply modern public econom? alternative use a unit of resource comes from.
ics, ignorance of the multi-good nature of this Further, in such economies it will not generally
problem, and, in some cases, ignorance of the be true that the private rate of return on invest?
difference between a social discount rate and ment (PRI) will be equal to the SRI. And simi?
a pure time discount rate. Given this pervasive larly, private discount rates (PDRs) can diverge
confusion about the basic theory of discounting, from SDRs. Such divergences can arise from all
it seems worthwhile to clarify briefly the logic forms of market imperfections, including exter?
of discounting as applied to climate change and nalities. In this case we have the additional com?
relate it to some simple empirical data. plication that key players, future generations,
havegeneral
are not directly represented. Thus, in the a reading on the concept at issue here, the
case:
social discount rates for the key goods. Thus,
observations on the PRIs and PDRs have only
PDR^SDR^SRI^PRI. limited usefulness. And note that the problems
that prevent the equalities in this chain, such
Before looking into discount rates along aas missing markets, unrepresented consumers,
given path, we should remind ourselves that the
imperfect information, uncertainty, production,
most basic mistake here is to use a marginal and consumption externalities are all absolutely
concept (discount rates) around a current pathcentral for policy toward the problem of climate
for strategic choices and comparisons among change. We come back again to a basic con?
paths. Policy on climate change means choosingclusion: the notions of ethics, with the choice
among paths with very different growth patterns of paths, together determine endogenously the
for a whole collection of capital goods, includ? discount rates. There is no market-determined
ing those relating to natural endowments. Thus,rate that we can read off to sidestep an ethical
discussion.
it is simply wrong to look at rates as currently
observed, or in historical terms, which refer to It must surely, then, be clear that it is a seri?
existing paths. A choice among paths means ous mistake to argue that the SDR should be
also choosing the implied set of discount rates
anchored by importing one of the many private
associated with the paths (Stern 2007, 27-31;rates of return on the markets (or a rate from
for more on this issue see Cameron Hepburn government manuals, or a rate from outside
2006). This is simply another way of expressing empirical studies). Yet it is a mistake that many
the old idea that the shadow prices or marginalin the literature have made. Nordhaus (2007b,
values depend on where you are. It is absolutely690) and Martin L. Weitzman (2007b), for
fundamental here for this very nonmarginal setexample, substitute a market investment return
of choices to recognize that the social discountof 6 percent for the SDR, thus producing a rela?
rates are endogenous, not exogenous. They are tively high 6 percent rate of discount on future
determined by ethical values, which have to beconsumption. This mistakenly equates the
PRI to the SRI and the SRI to the SDR. Such
discussed explicitly, and by the paths that result
from climate change and investment choices. an approach is entirely inappropriate given
Let us suppose, however, that we go past thisthe type of nonmarginal choices at issue and
problem and look at discount rates around the a risk structure of the problem, and in light
given path, or path of choice. What can we learn
of developments in modern public economics,
from observed rates in markets? Rates at whichwhich encompasses social cost-benefit analysis
households can borrow and lend, usually for and which takes account of many imperfections
periods of no longer than three or four decades,in the economy, including unrepresented con?
give a reading on their private discount rates or
sumers, imperfect information, the absence of
PDRs (assuming they equate their discount ratefirst-best taxes, and so on.
with their market rate, with some appropriate If, despite these difficulties, we nevertheless
treatment of uncertainty). But as this borrowing
insist on looking to markets for a benchmark rate
of discount, then what do we find? In the United
and lending takes place through private deci?
sions made by individuals acting in a market,
Kingdom and United States, we find (relatively)
this does not necessarily answer the relevant
"riskless," indexed lending rates on government
question in the context of climate change deci?bonds centered around 1.5 percent over very long
sions by a society?namely, how do we, acting periods. For private very long-run rates of return
together, evaluate our responsibilities to future
on equities, we find rates centered around 6 or 7
generations over very long periods? percent (Rajnish Mehra and Edward C. Prescott
2003, 892; Kenneth J. Arrow et al. 2004, 156;
Rates of return on investment generally reflect
private rates of return narrowly measured. They Sree Kochugovindan and Roland Nilsson 2007a,
take no account of externalities, which are of
64; 2007b, 71). Given that it is social discount
the essence for this discussion. Thus, even if
rates that are at issue, and also that actions to
we think we can observe some private rates ofreduce carbon are likely to be financed via the
discount for some households, and some pri? diversion of resources from consumption (via
vate rates of return for some firms, we do not
pricing) rather than from investment, it is the
14 AEA PAPERS AND PROCEEDINGS MAY2008
long-run riskless rates associated with consumer (2004), and also the Stern Review (Stern 2007,
decisions that have more relevance than those 60). Environmental services are also likely to
for the investment-related equities. Thus, even be income elastic, which will further reduce the
if one were to endorse the approach of import? implied SDR.
ing a discount rate from markets, when one uses Finally, we underline an unhappily common
the rate of return closer (but not equivalent) to mistake?namely confusing the pure time dis?
the relevant concept?the risk-free rate?it is count rate (PTDR) with the SDR. With a very
far from clear that one would obtain a rate of simple single good structure and consumption
discount on future consumption as high as the 6 at time t having social value u(c)e~8\ we have
percent advocated by Nordhaus (2007b, 690). the SDF, ?, as u'(c)e~8t.13 Its proportionate rate
Weitzman (2007c) has recently produced an of fall (the SDR) is T](c/c) + 5, where 77 is the
interesting insight into the difference between elasticity of the social marginal utility of con?
the riskless rate and equity returns in terms of sumption with respect to consumption.14 Often
perceived high weights in the downside tail of 77 is taken to be a constant. In this very simple
equity returns?the implication being that the case, we can now see the difference between the
perceived equivalent return on equities, allow? SDR and the PTDR. The PTDR is the rate of
ing for risk, is close to the lower riskless rates. fall of the value of a unit of consumption, simply
In this context Weitzman (2007a, b), has also because it is in the future, quite separately from
suggested encapsulating risk and uncertainty in the levels of consumption enjoyed at the time.
some contexts into discount rates. In my view, Here, the PTDR is S. For example with 8 = 0,
however, it is far more transparent to treat risk r] = 1.5, and tic ? 2.5 percent, we have a social
directly through the approach to social welfare discount rate of 3.75 percent, in excess of the UK
under uncertainty than to squash it into a single government's test discount rate (Her Majesty's
parameter that tries to reduce the problem to one Treasury 2003), notwithstanding a PTDR of
of certainty. zero. It is 77 and the growth rate that capture the
Suppose, however, that we persisted with idea that we should discount the consumption
the argument that it is better to invest at 6-7 of future generations on the basis that they are
percent and then spend money on overcom? likely to be richer than ourselves. This reason
ing the problems of climate change later rather for discounting is, and should be, part of most
than spending money now on these problems. models, including those of the Stern Review. We
The multi-good nature of the problem, together shall show in the next subsection that the cost,
with the irreversibilities from GHG accumula? in terms of climate changes, of weak or delayed
tion and climate change, tell us that we would action in the formal models is much greater than
be making an additional mistake. The price of that of timely and stronger action, in terms of
environmental goods will likely have gone up abatement expenditure, over a range of param?
very sharply, so that our returns from the stand? eter values for 77.
ard types of investment will buy us much less in A S of 2 percent (3 percent)?as endorsed by
reducing environmental damage than resources many commentators such as Nordhaus (2007b)
allocated now (see also Section I on the costs
of delay).12 This reflects the result that if envi?
13 The SDF is the marginal utility of consumption
ronmental services are declining as stocks of
time t (and we normalize the SDF to one for / = 0). I
the environment are depleted, then the SDR consider a changing population N(t), and replace u{c
with that good as numeraire will be negative. Nu(c) where c is C/Nand C is total consumption at tim
On this, see the interesting work by Michael the partial derivative with respect to C is u'(c).
Hoel and Thomas Sterner (2007), Sterner and 14 Unfortunately, some, including Nordhaus (200
and Weitzman (2007b), have been tempted to think th
U. Martin Persson (2007) and Roger Guesnerie value for the PTDR can be "backed out" from this exp
sion by equating the SDR with some market rate of retu
For example, with a market investment return of 6 perc
12 The issue is still more complex in this context, as consumption growth of 2 percent, and 77 = 2, one "in
delays in action result in environmental damage along the that 5 = 2 percent. Thus, the fallacy that the SDR can
way, as well as increasing the cost of achieving a given sta? anchored by some market rate of return leads to a se
bilization level. On balance, the extra intertemporal com? fallacy, namely that society's PTDR can be "revealed"
plexity is likely to strengthen this paper's argument in this market behavior (instead of requiring explicit specific
case. on ethical grounds).
and Weitzman (2007b)?implies that theDistributional

util? Judgements.?Having seen
ity of a person born in 1995 (1985)thewould be of importing a discount rate
implausibility
"worth" (have a social weight) roughly half
from that
outside the model to sidestep ethical judge?
of a person born in 1960. This type of discrimi?
ments, let us turn to the ethics relating to the
distribution
nation seems very hard to justify as an ethical of consumption or income, at least
proposition and would be unappealing in toitsmany.
very narrow form of 77 within the narrower
Indeed, the ethical proposition that 8 cases (as in be
should the models that follow) where the
very small or zero has appealed to asocial
long lineis the expectation of the inte?
objective
of illustrious economists includinggral Frank P.
of 2/ w(c,K5' (Stern 2007, 50-54).15
Ramsey (1928, 543), Arthur Cecil Pigou
Thinking (1932,
about 77 is, of course, thinking about
24-5), Roy F. Harrod (1948, 37-40), value
Robert M.
judgements?it is a prescriptive and not
Solow (1974,9), James A. Mirrlees (Mirrlees andexercise. But that does not mean
a descriptive
Stern 1972), and Amartya Sen (Sudhir that tjAnand
is arbitrary; we can, and should, ask
and Sen 2000). I have heard only one aboutethical
"thought experiments" and observations
argument for positive 8 (Wilfred Beckerman
that might inform a choice of 77. In so doing we
and Hepburn 2007; Simon Dietz, Hepburn,
must remember and that 77 plays three roles, guiding
Stern 2008) that has some traction?namely
(a) intratemporala distribution, (b) intertemporal
distribution,
temporal interpretation of the idea that one will and (c) attitudes to risks. We look
have stronger fellow feelings for those closerof empirical data for each of the
at the relevance
three
to us (such as family or clan) relative toin those
turn.
more distant. This is often explained in terms
Intratemporal Distribution: Let us begin
of functionality for survival of groups. However,
with a thought
this type of reasoning from evolutionary biol? experiment concerning direct
ogy does not have much relevance when we are transfers in a very simple con?
consumption
thinking about the survival of the text.
planet as ka times the consumption of B, the
If A has
whole. social value of a unit of consumption to B is k1
For these reasons, the Stern Review followed times that to A for constant 77. For example, for
the tradition established by the economists cited k = 5 and 77 = 2, the relative value is 25 and a
above, adopting and arguing strongly for a 8 transfer from A to B would be socially worth?
that exceeds zero only in order to account for while even if up to 96 percent were lost along
the possibility of some exogenous event that the way (the so-called "leaky bucket"?Arthur
would render future welfare calculations irrele? M. Okun (1975)). While I might not regard that
vant?the exogenous extinction of humanity (for position as unacceptable, to take just one exam?
discussion of this interpretation of S, see, e.g., ple, it appears inconsistent with many attitudes
David Pearce and David Ulph (1995) and David to transfers. In this sense, many would consider
Newbery (1992)). On this basis, the Review an 77 of 2 to be very egalitarian. With 77 = 1,
adopted a S of 0.1 percent (although even this the 96 percent in the example above becomes 80
value for 8 appears to be quite large in relation percent because the unit to B is worth five times
to this interpretation, implying a probability of that to A. Some might regard even this position
exogenous extinction of around 10 percent in 100 as rather egalitarian.
years). For a project or program, the probability Value judgements are, of course, precisely
of exogenous extinction could be substantially that and there will be many different positions.
higher, and this is reflected in some cost-benefit They will inevitably be important in this con?
manuals or approaches; in our case, however, we text?they must be discussed explicitly and
are considering humanity as a whole. the implications of different values should be
My overall assessment of the discussion of examined. Examples follow of what we find
discounting in the context of climate change is when we turn to empirical evidence and try to
that it is disappointing. All too often it has failed obtain implied values (the "inverse optimum"
to come to grips with the basic concepts, with approach). Empirical evidence can inform, but
the key nonmarginal and uncertainty elements
at the core of the issue, and with the theories of
social cost-benefit analysis and modern public 15 The summation is across individuals existing at time /
economics of the last 30 or 40 years. and c? is the consumption of individual i.
not settle, discussions about value judgements? It is striking that there are some, such as
for further exploration see Dietz, Hepburn, and Nordhaus (2007b) and Weitzman (2007b), who
Stern (2008). In using such evidence, we must appear to argue for high 77 (equal to 2 or 3) in
constantly bear in mind two key issues. First, we intertemporal analysis yet do not bring out how
must ask about the relevance of individual deci? this is potentially inconsistent with standard
sions for the societal decisions about the prob? cost-benefit analysis treatments of intragen
lem at hand?here social decisions by the world erational distribution (which effectively assume
community now, bearing in mind consequences 77 = 0) or with some intratemporal tax and trans?
for future generations. And, second, if we infer fer policies.
values from decisions, we must ask whether we
have modelled well the decision processes, the Intertemporal Distribution: In discussions
objectives, and the perceived structure of the of 77 in an intertemporal framework, there has
problem as seen by the decision maker. been much focus on implied saving rates. Some
Anthony B. Atkinson and Andrea Brandolini (Partha Dasgupta 2007, 6; Nordhaus 2007b,
(2007) have produced an interesting set of 694-96), following arguments in Kenneth J.
examples on empirical income distributions and Arrow (1995, 12-17), have criticized the rela?
actual transfer schemes in relation to welfare tively high weight placed by the Stern Review on
weights.16 They conclude that constancy of 77 the consumption of future generations (whether
across a range of increases is difficult to "square via 77 or 8) by arguing that the Review's param?
with" the way that many transfer schemes occur eter choices can, in certain scenarios, imply
in practice; in addition, there are many exam? implausibly high optimal savings rates. As is
ples where policies appear inconsistent with 77 clearly explained in the Review (Stern 2007,
greater than one. For example, given the cur? 54), with 6 = 0, output proportional to capital,
rent income distribution in the United States, and no technical progress, the optimal savings
an 77 of two would imply that a redistribution rate is I/77. With 77 close to one, this would lead
from the fifth-richest decile to the second-poor? to very high optimal savings rates. At the same
est decile would be welfare-improving even if time, the Review also states clearly (Stern 2007,
only 7 percent of the transfer reached the recipi? 54) that this result is highly dependent on model
ent; for a transfer from the richest decile to the assumptions.
second-poorest, virtually any redistribution Brad DeLong, in a short blog entry (DeLong
would be welfare-improving regardless of loss 2006), points out this flaw in the Dasgupta
along the way, so long as the recipient received Nordhaus position and argues that techni?
some benefit (Atkinson and Brandolini 2007, cal progress would greatly reduce the optimal
14). Of course, interpretation of actual intratem? savings rate. Mirrlees and Stern (1972) presented
poral tax and transfer schemes will depend on a more fully developed argument. Using a
many assumptions about the structure of incen? standard one-good, infinite-horizon Ramsey
tives17 and policymaking procedures. Perhaps growth model, constant returns to scale, and a
people think that tax-transfer disincentives are Cobb-Douglas production function, they show
very strong and they oppose transfers for these that under one specification?with constant
reasons. Or notions of rights and duties may population, a competitive share of capital equal
influence them. The upshot is that empirical to 0.375, and 3 percent exogenous technologi?
estimates of implied welfare weights can give a cal progress?the optimal consumption path
wide range of 77, including 77 below one and even for 77 = 2 and 8 = 0 involves a savings rate, s,
as little as zero. between 0.19 and 0.29 (or 0.23 if constrained to
a constant s). This is far below the 0.5 that would
be optimal with 77 = 2 and 8 ? 0 in the simpler
16 The welfare weight on an individual with consump?
tion c is taken here as the social marginal utility of con? case of output proportional to capital and no
sumption at that level. To keep things simple, we assume technical progress.
that this depends only on the individual's consumption and Just as with intragenerational values, the
not on her preceding consumption or the consumption of
others. approach of the "inverse optimum" or implied
17 See, for example, Stern (1976), who shows how sensi?
social values does not take us very far in this
tive tax calculations are to assumptions about substitutabil context. We cannot really interpret actual sav?
ity between goods and leisure. ing decisions as revealing the collective view
of how society acting together should

are see its
comparing strategies that yield very
entdistri?
responsibilities to the future in terms of paths. Third, within this framework
butional values?too much depends onfocus
assump?
the discussion on elasticities of mar
social
tions about how decisions are made in a utility 77 and pure time discount r
society
butwork?
and on how the participants perceive the in so doing we must recognize the
ings of the future economy. Observednarrowness
aggregate of this approach. Fourth, dire
savings rates are sums of individual cal discussion of 77 and 8 suggests a broa
decisions,
forThis
each taken from a narrow perspective. 77, although
is the consequences for
not the same thing as a society trying transfers
to work suggest that many would regar
out responsible and ethical collective action?
excess of 2 as unacceptably egalitarian;
the crucial issue for climate change. other hand, there appears to be little in
of ethical arguments to support 8 muc
Attitudes to Risks: "Guidance" on zero.
77 from
Fifth, within a marginal analysis fr
analyses of risk and uncertainty iswork,
even the
less relevant concept for discountin
informative. We can interpret 77 as the is the SDR. In the narrow 77-S context, w
param?
eter of relative risk aversion in the context of2,
of 1 to anvery low S, and growth at 1.5-2
expected utility model of individual cent,19
behavior.
we find an SDR of 1.5-5 percent,
However, the expected utility model is is close to ranges for long-run consum
unreliable
borrowing
as a description of attitudes to risk. Further, we rates and (at least in the UK) g
see a whole range of behavior, from the accep?
ment discount rates for program evaluati
tance of "unfair risks" in gambling (similar to 77
< 0) to extreme risk aversion in insurance (very C. Formal Modelling
high 77). And even if behavior were somewhat
more "rational" in the narrow sense of conform?
Aggregate models have been popular
ing to the expected utility hypothesis,economics
it would of climate change. They at
still be unclear how sound a basis it would be for
to integrate the science of climate cha
expressed,
the specification of a prescriptive value for use for example, via GCMs, wit
in this context. nomic modelling and are termed integ
assessment models, or IAMs.
From this very brief discussion of empirical
information, which might help us to think As Iabout
have argued, it is very hard to belie
models
77 in a prescriptive context, our conclusion where radically different paths
is that
there is very little to guide us.18 Again,
be compared,
we are where time periods of hund
years must be considered, where risk and
pushed back to the standard moral philosopher's
approach of trying to think through simple
tainty are of the essence, and where man
examples, i.e., the thought experiment. cial economic,
It has the social, and scientific featu
great virtue of facing the issues directly?it is
poorly understood, can be used as the mai
transparent and clear. titative plank in a policy argument. Thus,
What do we conclude about ethics while
and dis?
imposing some discipline on some a
counting in this context when we clearof
the vari?
the argument, risk either confusing th
ous confusions out of the way? The or answer is out crucial features of the pr
throwing
fairly simple. First, we must address theA ethics
related but different point is the
when modelling of costs of abatement
directly. There is no simple market information
from intertemporal choices or otherwisegrated with modelling of damages from
that can
give us the answers. Second, if we express thevehicles for optimization anal
sions, as
problem in standard welfare economic terms,
i.e., portray the objective as an expectation of an
integral of social utility, we cannot use marginal
19 In Section IIC we consider 77 in this range.
approximations to changes in welfare since rates
growth we are not examined in detail. The m
would have to take account of a changed path of
with earlier damages. With risk distributions app
to current knowledge, our preliminary findings
18 Thirty years ago (Stern 1977), I examinedthat
all three
estimated damages from climate change are
of these methods with no particularly strong conclusions,
be well above the cost of action to drastically redu
risks.
other than that the results covered a broad range.
this respect, they are still less credible. Those temperature, via climate change. Of the ethical
of us schooled in the optimal tax and optimal elements, the following are crucial: the type of
growth analysis of the 1960s, 1970s, and 1980s ethical values considered (including the role of
learned just how sensitive model results can rights and obligations); the type of outcomes
be to simple structural assumptions, such as introduced into evaluation functions (including
the form of preferences, production, or techni? separate goods or services such as environment,
cal progress, even before parameter values are health, and standard elements of consumption);
introduced (Atkinson and Joseph Stiglitz 1976, the functional forms used to capture evaluations;
1980; Angus Deaton and Stern 1986). and the parameters within those functional
The models portrayed here should be seen forms, including those covering intra- and
as helpful supplements exploring some serious intergenerational values. The ethical discussion
logical and modelling issues related to the esti? should not be shoehorned into a narrow focus on
mation of damages from BAU and their com? just one or two parameters such as 77 and 8; the
parison with alternative paths. We shall see, not ethical issues and their interactions with a model
surprisingly, that the key assumptions influenc? structure designed to reflect a range of uncer?
ing damage estimates concern risk and ethics. It tainties are much broader and deeper.
is surprising, however, that these two issues did
not occupy until recently the absolutely central Stern Review Damages and Sensitivity.?The
position that the logic of the analysis demands. Stern Review base case had damages from BAU
The result is that?given the recent evidence on relative to no climate change of around 10 per?
emissions, carbon cycles, and climate change cent of consumption per annum measured in
sensitivity?most of the studies prior to a year terms of the Balanced Growth Equivalent, or
or two ago grossly underestimated damages BGE (see Mirrlees and Stern 1972). Here, the
from BAU. BGE for any given path is calculated from the
The PAGE20 model was chosen for the work of expected social utility integral of that path by
the Stern Review first, because, in contrast with asking "what initial consumption level, growing
a large majority of preceding work, it places risk at a given growth rate and without uncertainty,
and uncertainty at center stage. It provides for would give this expected social utility inte?
a Monte Carlo analysis of explicit distributions gral?" The difference between the BGEs with
of a large number of parameter values. Second, and without climate change can be thought of as
Chris Hope, its originator, chose the parameters the premium, in terms of a percentage of annual
and their distributions to straddle a range of cli? consumption, that society might be willing to
mate models, IAMs, and economic models in pay to do away with the risk and uncertain?
the literature. Third, Chris Hope kindly made ties associated with dangerous climate change.
the model available and was very generous with Essentially, the BAU provides a calibration in
his advice. The model was described extensively terms of consumption (useful since "expected
in Chapter 6 of the Stern Review as well as by integrated utils" are hard to interpret) for the
Hope (2006a, b) and Dietz et al. (2007a, b). expected utility integral: it summarizes an aver?
Key assumptions on the form of the models age over time, space, and possible outcomes.
and of the parameters in these models may be Table 2 presents some of the results of the
grouped into two broad headings: the structural PAGE model. The parameter 77 was discussed
elements that shape the estimated consequences in Section IIB and is the elasticity of the social
of different kinds of emissions strategies, and marginal utility of consumption where the inte?
the ethical elements that shape the evaluations grand for expected social utility is the sum over
of different outcomes. Of the structural elements / of Niu{Ci/N^)e~0\ and where Q and N? are
in this approach, four are crucial: the emission consumption and population in region /. In the
flows; the functioning of the carbon cycle link? model, y is the exponent of a power function
ing flows to stocks; the climate sensitivity link? linking temperature T to damage through the
ing stocks to temperature; and the damages from function AT7 (Stern 2007, 660?the damages
vary by region). Table 2 provides BGE differ?
ences (in percent) across paths without and with
20 PAGE 2002, Policy Analysis of the Greenhouse Effect climate change, with a 5-95 percent confidence
2002 Integrated Assessment Model, see Hope (2006a, b). interval in brackets. We think of increases in y
Table 2?Sensitivity of Total Cost of Climate Change to Key Model Assumptions

(Definitions in text)
Damage function Consumption elasticity of social marginal utility (17)

exponent (y) 1 1.5 2
2 10.4(2.2-22.8) 6.0(1.7-14
2.5 16.5 (3.2-37.8) 10.0(2.3-24
3 33.3 (4.5-73.0) 29.3 (3.0-57.2
Note: Units are percentage losses in the BGE relativ

discussion).
Source: Dietz et al. 2007b.
as capturing increases in the structural risks,21 costs of the damages from climate change that
and of increases in 77 as capturing increases in would thereby be avoided. While the measure?
aversion to inequality and risk. ment of estimated damages may vary, this key
Intuitively, we can think of y as combining lesson is robust to parameter changes.
both the relation between temperature and dam? In this type of modeling, results are highly
ages, and the distribution of temperatures aris? sensitive to assumptions on both structural risks
ing from a certain emission path. These are, of and ethics, suggesting that great care should be
course, distinct effects, but both an increase in exercised in choosing the key parameters. We
y and a broader distribution for the temperature can illustrate the importance of these two issues
(in particular more weight in the upper tail, in terms of both computations in the model and of
either from a weakening in the carbon cycle or general results. Replacing all random variables
from higher climate sensitivity) has the effect in the PAGE model by their modes brings down
of producing a higher probability of large dam? the central case of damages from BAU from 10
ages. The effects are treated separately in the 11 percent to 3-4 percent.23 Thus, it is wrong
Review (Chapter 6 and the Technical Annex to to argue, as Dasgupta (2007) and Nordhaus
Postscript), where many more sensitivity results (2007b) have, that the Chapter 6 results of the
are given. These two processes (damages and Stern Review arise solely from assumptions
temperature distributions) can and should be related to ethics, in particular the use of 17 =
modelled separately, but here we keep the dis? 1 and, at least in the view of Nordhaus, a low
cussion and presentation as simple as possible. 8. Both risks and ethics are crucial to any seri?
While we shall discuss results in terms of ous assessment of policy toward climate change
the sensitivity of estimated damages with and and, in particular, assessment of damages from
without climate change, we must emphasize that BAU.
stabilization at 550ppm C02e removes around A formal result is provided in Box 1, which
90 percent22 of the damages (Stern 2007, 333), shows that for any given set of structural risks
so that we are essentially comparing two strate? and a utility function, pure time discounting (a
gies, namely BAU and stability below 550ppm key element in the ethics) can be set so that the
C02e. A key broad lesson from this type of estimated damages are as small as we please.
modelling is that the costs of stabilizing below Further, for any given pure time discounting,
550ppm C02e are generally far lower than the risks and utility can be set such that damages
are as big as we please.
Recently, in a series of papers (Weitzman
21 To keep things simple, the results in the table have y
fixed?that is, nonstochastic. The Monte Carlo probabili? 2007a, b), Marty Weitzman has argued that
ties are therefore generated by the variations in the many when we consider how the various different
other parameters. In the Postscript to the Review (Stern
2007, 658-71), stochastic y is presented. The base case of
y fixed and equal to 2 in Table 2 corresponds closely to the
base case for stochastic y in Chapter 6 of the Review and 23 See Dietz et al. (2007a, c). The drop from replacing
the Technical Annex to Postscript. all random variables by their means is smaller but still
22 Measured in terms of BGE. substantial.
Role for Both Risk and Ethics
? Write expected utility integral as ?Qg(t)f(t) dt, where g(t) = E[u(c)}, and u is
the welfare difference without and with climate change; f(t) is the pure time dis?
count factor. g(t) will depend on model structure, policies/path, and shape of u (c).
It is possible that g(t) is infinite for some finite T (see Weitzman 2007a).
? For any given g(t), we can construct/(i) so that J*g(t)f(t) dt < e for any e >
0, i.e., there are arbitrarily small losses from climate change. An example is/(i) =
{\/g(t))e~?tmth?> Vs.
? For any given/(i), we can construct g (t) so that there are infinite losses from cli?
mate change, i.e., ?Qg{t)f(t) dt = ??. An example is g(t)= Vf{t).
? Clearly, both ethical values and risk play key roles.
Boxl
probability distributions (particularly of climate and damages is an example of Knightian uncer?

sensitivity) that might arise in different models tainty, and he shows, using recent mathematics
can or should be combined, there is a convinc? on how the von Neumann-Morgenstern axi?
ing case for strong weights in the tails of overall oms might be modified, how strong weights are
temperature and damage distributions. These likely to be (or should be) attached to the worst
can lead to divergent (i.e., infinite) estimates of outcomes. We might see his approach, together
expected damages. His arguments are powerful with that of Marty Weitzman, as a mathematical
and persuasive, underlining strongly the crucial embodiment of the precautionary principle.
role of risk in this story and raising questions on Other forms of sensitivity are summarized
the use of the expected utility approach. only briefly here?see the Stern Review for
It is interesting to note that divergence of inte? more details. We comment on some specifics
grals can occur in three ways in this expected util? of a weakening carbon cycle on the structural
ity integral: first, via uncertainty, as Weitzman side; and pure time preference, intragenerational
emphasizes; second, via intragenerational dis? issues, and a narrower view of dimensions of
tribution (for example, this can occur for thedamage on the ethical side. The Stern Review
Pareto distribution of income, Christian Kleiber had a "base climate scenario" (Stern 2007, 175)
and Samuel Kotz 2003, 59-106); and third, via which ruled out a weakening carbon cycle and
integration over time. Indeed, for 77 = 1 and 8 included only very moderate positive natural
= 0, with positive growth the time integral is on feedbacks. These are known to be possibili?
the borderline of convergence (Stern 2007, 58). ties, but are not sufficiently well understood to
Thus, for 77 = 1 and 8 = 0.1 percent, the bulkenable calibration for most modelling purposes.
of the changes (in terms of the expected utility A "high-climate scenario" (Stern 2007, 175)
integral)?over 90 percent?occur after 2200. introduced increased changes for the carbon
For 77 = 2, the proportion is around 10 percent cycle, covering plant and soil respiration and
and for 77 = 1.5 around 30 percent. For some possible methane emissions from thawing per?
(e.g., William Cline 2007), this is an argumentmafrost, but these effects as modelled now look
for 77 higher than one, and I have some sympathy fairly small in relation to current scientific con?
with this view. cerns. This added a 4 percent extra BGE loss
Claude Henry (2006; Stern 2007, 38-39) has from BAU relative to no climate change. We
argued that our lack of knowledge on which of the also experimented with higher climate sensi?
probability distributions to use for temperature tivity?see Box 6.2 of the Review (Stern 2007,
179)?although we did not publish results.

of worldItconsumption or GDP, stabilizin
seems now that the "high +" scenario 550ppm
discussed C02e is still a good deal. Th
there may be of real relevance. statement that the costs of strong and
The PAGE model used in the Review action are much less than the costs of w
includes
some damage estimates from nonmarket delayed action is very robust. Let us u
effects
such as health. If these are removed, the base
again, however, that the Review gives st
weight to
case damage estimates drop from 10 percent in terms of space and emphasi
5 percent. Unsurprisingly, results arebottom-up
sensitive risk evaluation approach than
to pure time discounting. A pure timetop-down
discount aggregate modelling approach.
rate of 1 percent implies, under the extinction
Comparison
view of discounting, only a 60 percent chance with Other Model
Damages.?Much
of the world surviving the next 50 years, which of the earlier literature
mate
most would regard as a very pessimistic modelling found damage results tha
number.
lower
Nevertheless, as the Review's Technical than the results in the Stern Re
Annex
to Postscript shows, even with 8=1 Much of this earlier work underestima
percent,
emission
damages from BAU are likely to be higher thanflows (see below), suppresses
lightly
the costs of a mitigation strategy that touches on risk, takes an extraor
removes
the bulk of the risks. ily low view of damages from tempe
We did not carry out an examination in the and embodies very high pu
increases,
model of intragenerational issues in any detail,
discounting with little explicit ethical di
but comparisons with other studiesas suggested
to why (see Section IIB).
that these could add around a quarterAs or Figure
more 5 shows, Richard S. J. To
to loss estimates (for r\ around 1), inand
thisNordhaus
case (Nordhaus and Joseph G
another 4-5 percent. Starting with the 2000)
base essentially
case suppress uncertainty
of BGE losses of 10-11 percent, these climate
variations
sensitivity by using point estima
(-5 percent for a narrower view ofnot
damages,
spreads.26 There are some minor a
+4 percent for higher climate response,to +4 or on"
"add 5 risk, but it is not given the
percent for intragenerational issues) gave
role us the
demanded by the science and the ec
range of 5-20 percent losses per annum from
ics. The range covered by PAGE is cau
BAU that has been widely quoted. These
climateare
sensitivity, using only triangular
averages in three senses: over time, over space,
butions for its parameters?its full sprea
and over possible outcomes. all Monte Carlo runs is within the IP
In Chapter 13 of the Review, different meth?
''likely (66 percent confidence interval) r
ods for looking at stabilization are The
examined,
Meinshausen (2006) spread covers
starting with the bottom-up or risk-evaluation
percent confidence interval for the full r
approach of Chapters 1, 3, 4, and 5models
(and Sec?
he surveys, some of which go far
tion I). The discussion of the top-down Figure
damage 6 summarizes results by Men
(Mendelsohn
modelling approach, used in this section of the et al. 2000) and Toi (2002
paper and in Chapter 6 of the Review,astonishingly
explains low damages of 0-2 per
that the 10-11 percent BAU base-case GDP damage
from temperature increases as h
costs are reduced to around 1 percent 5-6?C.
for stabi?
The Nordhaus and PAGE (Chris
lization at 550ppm C02e (Stern 2007, 333)2006a)
Hope i.e., damages in terms of outp
the cost saving from avoided damagesfairly
of stabi?
close together, although arguabl
lizing at 550ppm C02e is 9-10 percent. When
too small in relation to the possible impl
compared with costs of stabilizationof at 5-6?C
550ppmtemperature increases.
C02e of around 1 percent of world consump?
These early models have given rise to a
tion or GDP24 (see Section IB above),erful
this and
sav? unjustified bias against str
ing from action represents a very good return.
timely action on climate change. The q
Even if damages avoided are only 3-4 percent
25 A valuable review can be found in Geoffr
(2007).
26 Their models
24 Over time, 1 percent of consumption and 1 percent of (FUND for Toi and DICE/RICE for
GDP are broadly equivalent. Nordhaus) can, however, be used for Monte Carlo studies.
FUND 2.8
DICE/RI?E -
PAGE2002(100%)
IPCC AR4 WMtf range (66%)
Meinstaisen(90%)
Eventual temperature change (relative to ore-industrial)
Figure 5. Estimates of Climate Sensitivity from IAMs Compared to GCMs
Sources: Toi 2002; Nordhaus and Boyer 2000; Hope 2006a; 2006b; IPCC 2007; Meinshausen
2006.
is not so much why the Stern Review's model? (b) The carbon cycle is likely to weaken as
ling obtained high damages under BAU, as why a result of, for example, the possible col?
the earlier literature made assumptions that give lapse of the Amazon forest at temperature
such low results. increases of above 3-4?C, or the decreas?
ing absorptive capacity of the oceans.
D. Damages and Sensitivity, Further, a thawing of the permafrost is
One Year On from the Review likely to result in strong methane release.
Looking back, I think the Review was (c) The climate sensitivity assumed in the
too cautious on all four of the key structural Review is likely to be conservative (as
elements: (a) emissions growth, (b) carbon cycle, argued in Section I).
(c) climate sensitivity, and (d) damages from a
given temperature. (d) The damages from given temperature
increases assumed in the Stern Review
(a) The work of Ross Garnaut and his seem very low. The Review's mean dam?
Commission, working for the new age loss (based on estimates in the eco?
Australian government on climate change, nomic literature) from 5?C was around
is revisiting the emissions scenarios in 5 percent of GDP (Stern 2007, 180). As
the IPCC Special Report on Emissions argued in Section I, a temperature increase
Scenarios or SRES (IPCC 2000). In its of 5?C would most likely result in massive
Chapter 6 model (Stern 2007, 173-88), the movements of population and large-scale
Stern Review used the second highest of conflict.
the four scenarios (called A2). Garnaut is
now suggesting that the highest of the four, Considering these structural factors together,
A1F1, is likely to be the best description of the modelling of the Stern Review probably
BAU (Garnaut 2007). Key among the rea? underestimated significantly the risks of high
sons is the growth rates of the developing damages from BAU, perhaps by 50 percent
world, particularly China and India, and or more if one compares the first two rows of
their continued strong emphasis on coal Table 2. Much of the earlier literature grossly
(ECIEP 2006). underestimated the risks.
NonJhaus, output
Toi, output
ToLequliy
0 1 2 3 4 5
Increase in global mea
Figure 6. The Modelled D
Source: Dietz et al. 2007a.
Looking at the reasons

both y and
of damage
hindsight, my esti
inclin
the base case from the
twofold: wh
sis is elements
undertaken farthejus
Table 2?thatapproach
is, with to
hig
indicated in nates,
Section unjust
IIB,
future" from 17
against =futu
1 an
gests that there is a case
it remains true III.
that Policy
man
tions of 77 = 2 for intra
as very At
egalitarian.the In hea
a
(17 ? 7) for
diagonal GHGs?t
is takin
of two to externali
commentators on
(2007a, b) structure
argued for b
g
and uncertainty,
to and
keep D
cost
egalitarian values
world than
witho
t
In
summary,be aone year
sufficie
Review, with the
But itbenefi
will
dence and valuable
the eco
risks, ur
views would difficulty
have been m
of
the case has price
been signal
streng
up, disaggregated,
market less
imp
approach isers,
preferable
and seri
in investigating
plankthe
of case
pol
is and
particularly accelera
weak in r
mization. should withi
Second, take
we have learned still
actions m
costs
issues are ethics and
efficiency. ri
F
look at them together
tional t
frame
damages. Third, our
estation, ow
whi
underestimated the And
failures. ris
international focus, to promote collaboration, less so than others and allow the balance of taxes
take account of equity, and reduce global costs. to adjust away from other taxes such as income
Careful analytical investigation by econo? or VAT; alternative uses of revenue are possible
mists of policies on climate change involves the too, including those related to climate change.
whole range of the tools of our trade, including We should beware, though, of arguments about
the economics of risk and uncertainty, innova? double dividends: environmental taxes have
tion and technology, development and growth, dead-weight losses in addition to their benefi?
international trade and investment, financial cial effects in addressing externalities. Taxes on
markets, legal issues, ethics and welfare, as well GHGs would require measurement of GHGs,
as public and environmental economics. It will just as in trading, but taxes on petroleum prod?
no doubt require the development of further ucts, coal, or other fossil fuels can act as fairly
analytical methods. And it necessitates close good approximations, avoiding direct emission
collaboration with scientists and other social measurement, which can be relatively costly to
scientists. small enterprises.
Our focus here in this very brief discussion As discussed in Section IA, where the world
of policy will be on price-oriented mechanisms is perfect other than in relation to the tax in
and on technology, but we should also note a question, quantity controls and price measure?
sixth key element that is often overlooked in dis? ments can have dual and essentially identi?
cussions of economic policy, namely how pref? cal effects. Where there is risk, uncertainty,
erences change as a result of public discussion. and imperfections in this market and in other
This was an integral part of John Stuart Mill's parts of the economy, there will be price uncer?
(Mill 1972 [1861], 262) perception of democracy tainty, quantity uncertainty, or both, depend?
and policy formation (see also the discussion in ing on the policies chosen and the nature of the
Chapter 9 of Stern, Jean-Jacques Dethier, and F. uncertainty. Both price certainty and quantity
Halsey Rogers 2005). In this context, it involves certainty are important: firms would like clear
a change in public understanding of responsi? and simple price signals for decision making;
ble behavior. Thus, people will spend time on quantity overshooting on emissions is danger?
separating out different elements of waste for ous. With learning and readjustment of pol?
recycling, or they will drive more carefully, not icy (although not so frequently as to confuse
only because there may be a financial incen? structures and issues), the difference in effects
tive for recycling or penalties for bad driving, between a tax-orientated policy and a quan?
but also because they have a view of responsible tity/carbon-trading policy may not be so large.
behavior. Given where we start, however, in my view the
Pricing an externality can be done in a number danger of overshooting emissions targets is of
of ways. First, there is carbon taxation; second, great significance.
carbon trading on the basis of trade in rights Tradable quotas, the second method of estab?
to emit which are allocated or auctioned; and lishing a price for GHGs, have the advantage
third, implicit pricing via regulations and stan? of providing greater certainty about quantities
dards which insist on constraints on actions or of emissions than taxes. The European Union
technologies which involve extra cost but which Emissions Trading Scheme (EUETS) has shown
imply reductions in emissions. Each of the three that a big part of the economy can be covered
has different advantages and disadvantages and (currently around one half of European emis?
all three are likely to be used. Understanding the sions) with relatively low administrative bur?
pros and cons, where the different mechanisms dens by focusing on major emitting industries,
can and should be used, and how to deal with such as power.
problems of overlaps, are all very important By starting with allocations that are not paid
issues. We have the space to look briefly only at for and moving to auctions, trading can build
a few of the relevant considerations. acceptance by industry because it allows for a
Taxes have the advantage of being imple less dramatic adjustment. Free allocations based
mentable by individual governments without on historical emissions do have important prob?
international agreement. All taxes are conten? lems, however: they are likely to slow adjustment
tious but those on recognized "bads" such as since immediate profit pressures are lower; they
tobacco, alcohol, or carbon emissions may be can give competitive advantages to incumbent
firms that may succeed in getting large quota

Further, difficulties arise in trading with coun?
allocations, thus reducing competitiontries
and pro?
that are not taking strong measures, price
moting rent-seeking; and they forego public
based or otherwise, against climate change.
revenue. Thus, moving to auctioning There
overis,time
in principle, a case for levying appro?
has strong advantages and should be apriate
clearborder
and taxes on goods from countries
transparent policy. that do not otherwise embody a carbon price. A
An aspect of quotas and trading thatsystem
is crucial
analogous to the operation of the border
is their potential role in internationalprocedures
efficiencyfor VAT could be envisaged. My own
view is that
and collaboration. Developing countries (seethis should be a last resort. There
next section) have a strong and understandable
are many searching for arguments on protection
that might
sense of injustice. They see rich countries hav? climb on the bandwagon. The best
ing first relied on fossil fuels for their way develop?
forward is to build international collabora?
ment, and thus being largely responsible for athe
tion with positive and constructive approach.
existing stocks of GHGs, then tellingRegulation them and to standards can give greater cer?
find another, and possibly more costly, route
tainty to
to industry. This can accelerate responses
development. They feel least responsible and for
allowthe
the exploitation of economies of
position we are in, yet they will be hit earliest
scale: lead-free petrol and catalytic converters
and hardest. are probably good examples. Misguided regula?
International trading provides for lower costs, tion, on the other hand, could reduce emissions
from the usual arguments about international in very costly ways. Again urgency points to a
trade, and provides an incentive for poor coun? role for regulation/standards, and careful eco?
tries to participate. These arguments on cost and nomic analysis can keep costs down. In thinking
collaboration are central to my view that there about these costs, however, we should remark
should be a very substantial focus on carbon that there are a number of examples in the his?
trading in the policy of rich countries, with open? tory of the motor industry where innovations on
ness to international trade, backed by strong rich safety or pollution were resisted by industry on
country targets for reductions, in order to main? cost grounds, only for compliance costs to turn
tain prices at levels that will give incentives both out to be much lower than manufacturer pre?
for reduction at home and purchase abroad. Rich dictions; for Environmental Protection Agency
and poor country targets will be discussed in the (EPA) vehicle emission control programs,
next section. industry stakeholders predicted price changes
Price volatility is sometimes said to be a prob? to consumers that exceeded actual changes by
lem with quotas and trading, and the EUETS is ratios ranging from 2:1 to 6:1 (John F. Anderson
cited as an example. But that scheme provided and Todd Sherwood 2002).
some basic simple lessons that have been learned: While taxation, trading, and regulation will
in its first stage (2005-2007), giving away too all have roles to play, it is important to think
many quotas collapsed the price. Quotas have carefully about how they might interact. For
been allocated with greater rigor and stringency example, if taxation and carbon trading overlap,
in the second phase (2008-2012) and the price there are likely to be problems in establishing a
for that phase is currently above ?20 per ton, clear and uniform price for carbon, leading to
already approaching the type of range indicated confused signals and inefficiency. And strong
as necessary. Volatility can be reduced by (a) regulatory targets such as renewables percent?
clarity, (b) firmness of quotas, and (c) broader ages could, without care, result in low demand
and deeper markets?greater trading across sec? on carbon markets.
tors, periods, and countries. Particular measures Our discussion of technology will be very
for dealing with volatility should be analyzed in brief, but in my view, policy in this area will
relation to, or after, these broader more market be of great importance?we cannot simply leave
friendly approaches. And care should be taken the correction of externalities to carbon mar?
not to restrict international trade as a result; for kets or taxation. There is a standard argument
example, differences in caps on prices in differ? on knowledge and technology which sees ideas
ent regions might, because of attempts to arbi? and experience as having positive externalities.
trage where prices are different but fixed, make Figure 7 shows that experience is indeed impor?
open trade difficult or impossible. tant in the electricity industry?it seems that in a
10
1985
1
??
o
O)
O)
D
?
LU
O Electricity from
o * biomass (-85%)
0.1
Supercritical coal (97%)

0)
o
o 1995
NGCC (96%)
0.01
0.01 0.1 1 10 100 1,000
Cumulative electricity production (TWh)
Figure 7. Cost of Electricity for Different Techn
Note: The number in brackets indicates speed of learning: 65 percent m

level after a doubling of production.
Source: Stern 2007, 254.
number of "less mature" technologies costs of

seen a number can
exciting and
fall quite sharply with cumulative
opments,experience.
such as in materials
Further, the rate of fall is different for different
other than silicon, for photovo
technologies. This tells us that
The public support aspects o
international
for deployment?such as feed-in
crucial
tariffs,
too. We
which
all gain from r
if others
may be different for different adopt cleaner tech
technologies?has
a strong foundation. Care Thus,
with applying such
a balance of private retu
incentives is necessary to avoid
for the dangers
example of
through patents,
must be
bureaucrats trying to pick private found.
sector This should b
techno?
logical "winners." deal or framework to which w
Research and development (R&D) in basic
IV. A Global
technologies also require public support. It is Deal
remarkable how much public support for R&D in
Climate
energy has fallen since the early 1980s change is global in
(see Fig?
its due
ure 8). Part of this was probably impacts.
to lowAn effective resp
energy
prices,27 but nevertheless fore be organized globally a
the now-recognized
urgency of developing low carbon technologies
international understanding a
requires a strong reversal ofCollaboration, if it is to be est
this trend. Private
and public sector R&D on energy have moved
tained, must be underpinned b
closely together and this is an
ciation
area that
wherethepublic
methods adop
private partnership to enhance(on both private
the scale and
required); efficien
social returns, and to cover different
down); and risks, will
equitable (respons
are allocated
be crucial. Fortunately, the last few yearsin have
ways that take
ability, and historical responsib
tive structures must be such t
27 Extensive privatization has probably played a role as
incentive-compatible.
well. For example, the UK's nationalized National Coal And cou
politicalBoard
Board and Central Electricity Generation support must be bui
had R&D
will sustain
departments of international distinction. policies over time.
0.18%
Figure 8. Public Energy R&D Investments as a Share of GDP
Source: Stern 2007,401.
Public support for action will more a framework in which each country, or
be founded
group of countries,
not only on recognition of the magnitude of can assess its own respon?
sibilitiesthat
the problem, but also on the realization and targets
it with some knowledge of
is possible to construct collaborative
where thepolicies
rest of the world is going and how it
can interact.It is a
that are effective, efficient, and equitable.
great responsibility of economists toOn targets?a
help key element of effectiveness,
design
those policies. And they must doorsoaction on an appropriate scale?we should
urgently?
be clear how
the international discussion is moving far the international discussion
quickly
has already
and key decisions will be taken over themoved.
nextThe G8-G5 summit chaired
few years. by Germany in Heiligendamm in June 2007
The following is my own attempt to describe declared a world target of 50 percent reductions
the outline of a possible global deal based on by 2050. As sometimes happens in international
the preceding analysis and on my own intensive communiqu?s, not all details (such as base date
experience over the last two years of involve? and levels of agreement among attendees) were
ment in public discussion, taking account of the clear; but it was a significant marker nonethe?
recent UNFCCC meetings at Bali last month. less. And it is broadly consistent with the type
Let us begin with overall reductions targets and of stabilization range, around 500ppm C02e
the allocation of responsibilities across coun? for example, discussed in Section I. In what
tries. Our earlier discussion of trading, technol? follows, unless otherwise stated, emissions
ogies, and deforestation will then allow us to see reductions will be measured from 1990, cover?
quickly the broad structure of a global deal. Let ing all GHGs (in the six-gas Kyoto sense) and
us be clear* at the outset that this should not be emissions sources. The Heiligendamm 50 per?
seen in the overly formal way of a WTO discus? cent target is for the world as whole and it is
sion, founded in legal structures, with compli? generally agreed (see below) that, in the spirit
ance driven by sanctions, and where no one is of the Kyoto language of "common but differ?
bound until the full deal is agreed. This is much entiated treatment," the richer countries should
take responsibility for reductions bigger than Policies that could support this constituted the
the average. In what follows, we shall think of subject of Section III and should be at the heart
rich country reductions as including those dis? of a global deal.
charged by purchases on international markets. Let us investigate equity in a little more detail.
At Bali in December 2007, three coun? The history of flows and their relation to future
tries, Costa Rica, New Zealand, and Norway, stabilization targets should, in my view, be
declared targets of 100 percent reductions by central to a discussion of equity. All too often,
2050, i.e., "going carbon-neutral." The latter equity is seen solely or largely in terms of the
two are highly likely to need international pur? relative level of future flows (for example, per
chases to get there. Note, too, that reductions of capita convergence by 2050). A few numbers and
more than 100 percent are possible?many in a little basic arithmetic will help to understand
developing countries would regard targets for the issues. Currently, global emission flows are
rich countries above 100 percent as appropriate, around 40-45 Gt C02e. With a world popula?
given past history?and that such reductions tion of around 6 billion, that means average
that would almost inevitably involve interna? global per capita emissions are around 7 tons.
tional purchase. Given that the world population in 2050 will be
California has a target of 80 percent reduc? around 9 billion, in order to achieve 50 percent
tions by 2050. France has its "Facteur Quatre": reductions (i.e., an aggregate flow of around 20
dividing by 4, or 75 percent reductions, by 2050 Gt C02e) by then, per capita emissions will have
(Stern 2007, 516). The United Kingdom has a to be 2-2.5 tons. And since around 8 billion of
60 percent target but the Prime Minister Gordon these people will be in currently poor countries,
Brown indicated in November 2007 that this those countries will have to be in that range28
could be raised to 80 percent (Brown 2007). even if emissions in currently rich countries
Australia, under the new government elected were to fall to zero. It is clear from this basic
at the end of November 2007, has now signed arithmetic that any effective global deal must
Kyoto and has a target of 60 percent (Kevin have the currently poor countries at its center.
Rudd 2007); 80 percent is under considera? From the point of view of equity, the num?
tion after the Garnaut Review is published next bers are stark. The currently rich countries are
summer. responsible for around 70 percent of the existing
Targets for 2050 seem far away but the stock, and are continuing to contribute substan?
long lifetime of many investments means that tially more to stock increases than develop?
early decisions are needed to reach them. ing countries. The United States, Canada, and
Intermediate targets are also being set. At the Australia each emit over 20 tons of C02e (i.e.,
European Spring Council, 20-30 percent targets from all GHGs) per capita, Europe and Japan
were set for 2020; Germany has set 40 percent over 10 tons, China more than 5 tons, India
targets by 2020. The European Council also set around 2 tons, and most of sub-Saharan Africa
targets for renewables and CCS for 2020 and much less than 1 ton. Recent per capita C02
beyond, but it is the overall emissions targets, emissions (i.e., omitting other GHGs) for some
and their achievement, which are crucial. How countries are illustrated in Figure 9.
they are achieved country by country will vary In the lower part of this graph are three big,
and must take account of economic as well as fast-growing developing countries. China is
environmental, social, and political consid? growing especially quickly. Even with fairly
erations. At Bali, many were pressing for rich conservative estimates, it is likely that, under
countries to accept 25-40 percent cuts by 2020. BAU, China will reach current European per
That is indeed in the right range for rich country capita emissions levels within 20-25 years. With
cuts of 80 percent by 2050 and is now at least its very large population, over this time China
an initial 2020 benchmark. Overall, in discus? under BAU will emit cumulatively more than
sions of global and rich country targets, ranges the USA and Europe combined over the last 100
consistent with the criteria of effectiveness and
equity are now the basic benchmarks, and many
key commitments have been made. Delivery
on targets at reasonable cost?essentially effi? 28 In this context, I am referring to absolute emissions
ciency?is, of course, crucial and a challenge. originating in the country rather than who pays.
26
1990 1891 1982 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Figure 9. Per Capita C02 Emissions (in tons)
Source: CDIAC 2007.
years. That is one indication of the urgency of C02e as a reservoir sized 270ppm C02e, which
finding a global response quickly. the world will get close to exhausting over the
But let us keep focused on equity. With 80200 years between 1850 and 2050. If we start
percent reductions by 2050, Europe and Japanthe clock in the late 1980s or now, it would be a
would be around the required two-ton globalreservoir sized around 140ppm C02e or 120ppm
average level. An 80 percent reduction by the C02e, respectively.
United States, Australia, and Canada by 2050 From this perspective, equalizing the per cap?
would leave them around four tons, twice theita flows of emissions?or the size of the glass
required average level. Thus, a 50 percent over? drawn per person per year from the reservoir?
all reduction and an 80 percent rich country by 2050, shortly before it is dry, is a very weak
reduction would still leave average rich countrynotion of equity. It takes no account of all the
flows above the world average in 2050. guzzling that took place by the better-off over
Turning to stocks, let us think about the paththe preceding 50-200 years (depending on when
from some initial level to a stock stabilization (towe start the clock). There is a very big difference
be specific, suppose that level is 550ppm C02e), between a stock and a flow notion of equity. An
and about who consumes what along the way. We 80 percent reduction of flows by rich countries
can think of the initial level as 280ppm C02e,by 2050, in the context of a 50 percent reduction
corresponding to preindustrial times (aroundoverall, is not a target for which rich countries
1850); or we could start 20 years ago (aroundshould congratulate themselves warmly as dem?
390ppm C02e), when the problems of climateonstrating a splendidly powerful commitment
change began to receive strong policy attention;to equity. And the contract-and-converge argu?
or we could start now (around 430ppm C02e).ment for some common flow level, or for using
One perspective on equity would be to see thesuch a level as the eventual basis of trading, on
difference between 280ppm C02e and 550ppmthe asserted grounds that there are "equal rights
to emit or pollute," does not seem to me to have and pace required. They feel the inequities of
special claim on our attention.29 Rather, the tar? the situation and phenomena acutely. Just when,
get of equalizing by 2050 (allowing for trade) they argue, they are beginning to overcome pov?
may be seen as being a fairly pragmatic one, on erty, in part by rapid growth, they should not be
which it might be possible to get agreement, and asked to slow down. Financing, together with
one that, while only weakly equitable, is a lot technology demonstration and transfer, will
less inequitable than some other possibilities, be needed to convince them that moving to a
such as less stringent targets for rich countries. low-carbon growth path is not the same thing as
If we take any particular good, it will gener? moving to a low growth path.
ally be true that rich people consume more than The third element refers to the short- and
poor people. That is simply an expression of medium-term approaches to trading between
their being richer. In the case of the reservoir, rich and poor countries. The current system, the
or the "contents of the atmosphere," it is hard Clean Development Mechanism (CDM), was
to think of an argument as to why rich people established by Kyoto and operates at the level
should have more of this shared resource than of a project in a poor country (a so called non
poor people. They are not exchanging their labor Annex 1 country in the Kyoto Protocol). If a firm
for somebody else's and they are not consuming in a rich country (an Annex 1 country) is part of
the proceeds of their own land, or some natu? a trading scheme (such as the EUETS) which
ral resource that lies beneath it. I do not have recognizes the CDM, then that firm can buy
any special "correct" answer to the challenge of an emissions reduction achieved by the project,
understanding equity here, but it is a challenge subject to the project using technologies or
we cannot avoid discussing. Any global deal will approaches from an admissible list. The amount
have to involve some implicit or explicit under? of the notional reduction comes from compar?
standing over the sharing of this "reservoir." ing the project with a counterfactual?what the
The key elements of the global deal have, with entity doing the project might otherwise have
one exception, now been raised and discussed. done. Approval of a project goes through the
Let me express the deal or framework in terms poor country authorities and a special institu?
of two groups of three headings, the first cover? tional structure, currently in Bonn. The system
ing targets and trade and the second covering is slow, cumbersome, and very "micro."
programs for which public funding is likely to Trading on the scale required to reach the
be required. This set of six policies or programs type of targets discussed (see Table 3) requires
is the international part of a deal. The domestic a much simpler, "wholesale" system.30 At the
policies will vary across countries, using dif? same time, to get agreement with poor coun?
ferent combinations of policy instruments and tries, it will have to continue to be "one-sided,"
technologies as discussed in Section III. The six as in the CDM, i.e., you can gain from innova?
elements of a global deal are expressed in bullet tion, but are not penalized for BAU. Wholesale
point form in Tables 3 and 4. measures can include technological benchmarks
The first element of the first group covers the such as employing CCS (currently excluded
targets. The global target was explained and jus? from CDM), or sectoral benchmarks such as
tified in Section I and the distribution of targets getting below a certain amount of C02 per ton
above in this section. The second, the impor? of cement. As one-sided trading measures, the
tance of emissions trading, was emphasized in benchmarks could be set ambitiously.
Section III: the justification for a major focus on After these trading mechanisms have been in
GHG trading in policy lies in its promotion of place (with associated technology sharing) for
both efficiency and collaboration. Unless financ? a while, developing countries will be able to
ing flows for the extra costs of reducing emis? have confidence that a trading system can work
sions are available to poor countries, they are on an appropriate scale. Then it would be rea?
extremely unlikely to join the effort on the scale sonable to ask them to accept targets consistent
29 Asserting equal rights to pollute or emit seems to me

to have a very shady ethical grounding. Emissions deeply 30 This scale is derived from preliminary calculations
damage and sometimes kill others. Do we have a "right" using a trading model at the UK Department of Environ?
to do so? ment, Food, and Rural Affairs (DEFRA).
Table 3?Key Elements of a Global Deal: Targets and Trade
? Confirm Heiligendamm 50 percent cuts in world emissions by 2050 with

rich country cuts at least 75 percent.
? Rich country reductions and trading schemes designed to be open to

trade with other countries, including developing countries.
? Supply side from developing countries simplifed to allow much bigger

markets for emissions reductions: "carbon flows" to rise to $50-$100
billion per annum by 2030. Role of sectoral or technological benchmar
keting in "one-sided" trading to give reformed and much bigger CDM
market.
Table 4?Key Elements of a Global Deal: Funding Issues
? Strong initiatives, with public funding, on deforestation to prepare for

inclusion in trading. For $10-15 billion per annum could have a pro?
gramme which might halve deforestation. Importance of global action
and involvement of IFIs.
? Demonstration and sharing of technologies: e.g., $5 billion per annum

commitment to feed-in tariffs for CCS coal could lead to 30+ new com?
mercial size plants in the next 7-8 years.
? Rich countries to deliver on Monterrey and Gleneagles commitments
on ODA in context of extra costs of development arising from climate
change: potential extra cost of development with climate change upward
of $80 billion per annum.
with overall global goals in the context of a The public funding requirements are grouped
strong set of goals by rich countries. If we look in three elements in Table 4. Each would require
for targets from poor countries now, the only a paper in itself for appropriate treatment,
ones that would be accepted would be far too and we can give only headlines. Deforestation
loose and would knock the bottom out of inter? accounts for up to 20 percent of current emis?
national trading, i.e., collapse the price. And in sions; the numbers are not easy to specify pre?
the future these loose targets would be likely to cisely?probably 5-8 Gt C02e per annum. These
form a base-line for subsequent discussion. That flows could be roughly halved, in my view, for
is why a staged approach is essential if currently around $5 per ton of C02, taking into account
poor countries are to accept participation in opportunity costs of land and the institutional,
responsible global stabilization so that by 2050 administrative, and enforcement measures nec?
their emissions average around 2 tons per capita. essary. Some have estimated higher costs (e.g.,
Recall that this is a half or a third of China's McKinsey?Enkvist, Naucl?r, and Rosander
current level. It is very unlikely to be possible 2007) but there appear to be large amounts of
to find financial flows on the scale required to "initial" reductions available at lower costs, par?
incentivize appropriate action from the public ticularly if programs are large-scale and coordi?
sector of rich countries. Witness the difficulty nated across countries (for further discussion see
in getting resources for Overseas Development Myers 2007; Daniel Nepstad et al. 2007; Niels
Assistance (ODA), which will be strained still Anger and Jayant Sathaye 2007). This would
further by the challenge of adaptation (see help to avoid reduced deforestation in country
below). The trading system provides for private A simply displacing activity and thus increasing
flows. deforestation in country B. Public sector flows
can be combined with private sector flows as the United Nations Development Programme
avoided deforestation is brought into the carbon (UNDP) estimated additional costs for develop?
trading process so that all countries are given ing countries of around $85 billion per annum
incentives. Indeed, one of the responsibilities of by 2015 (UNDP 2007, 15). And they will pre?
the publicly funded program would be to work sumably rise after that.
toward trading. Such extra financing will be hard to find. It
The second element in this second group, the may be compared with the $150-200 billion per
demonstration and sharing of technologies, is annum extra that would arise if the Organisation
urgent; financial resources must be made avail? for Economic Co-operation and Development
able and institutional arrangements designed. (OECD) countries moved to 0.7 percent GDP in
This is an important area for economic research. ODA by 2015, as many of them have promised.
One problem of particular urgency, for reasons The ODA promises of the 2002 UN International
described above, is the demonstration of CCS Conference on Financing for Development in
for coal. There are no current plants using CCS Monterrey, Mexico, in connection with the
for coal-fired generation on a commercial scale. Millennium Development Goals, and of the
From 2015 or 2020 on, the world will need most 2005 UK-chaired G8 Gleneagles summit on
of its new coal-fired electricity generation plants Africa, and preceding EU commitments in
to be operating with CCS if it is to have any July, were powerfully argued and justified at the
chance of realizing its targets. If CCS cannot time. They took little account of climate change.
work on the necessary scale, then we need to If that aspect is added, as it should be given
know soon and follow alternative strategies. At the magnitude of the challenge, and combined
present, however, it does look promising. There with the historical responsibilities for stocks of
is geological work to be done to identify storage GHGs and the implied consequences for poor
capacity, and careful legal and regulatory work countries, then the argument for 0.7 percent, in
to be done to allocate risk and responsibility. my view, becomes overwhelming. The Stern
Geology and coal vary greatly across the world Review left the argument at that point, although
and many demonstrations of commercial-scale a case could have been made for increasing the
plants are necessary. Feed-in subsidies, world? ODA targets.
wide, of around $5 billion per annum could sup? The framework I have now described does, in
port 30+ such plants over the next 7-8 years my view, meet the criteria of: effectiveness?it
and cover a broad range of examples.31 is on the right scale; efficiency?it relies heavily
There should also be support for many other on markets and market-orientated innovation;
technologies. We do not know what the most effi? and equity?it does at least give some specifi?
cient clean technologies will be in the future, and city to the "common but differentiated responsi?
the answers are likely to vary with location. CCS bility" already accepted internationally. It builds
is emphasized here simply because we can be on existing commitments and some aspects of
fairly confident that BAU will involve a great deal the current discussions in international fora. It is
of coal for electricity over the next 20-30 years. also designed to give some realistic opportunity
Perhaps it will be a medium-term technology and for the major developing countries to become
be replaced by others over the longer term. strongly involved, as they must if serious targets
Finally, in the global deal, I would emphasize are to be agreed and achieved.
an element that has not been discussed here and It is a framework that could allow all coun?
that will be of great importance. Even with very tries to move quickly along what they see to be
responsible policies, the world is likely to see a responsible path. What is very striking here
an additional 1-2?C of warming over and above is how broadly basic understanding has already
the 0.8?C it has already experienced. Adaptation been established. Country by country, we see
will be necessary worldwide and will be par? targets being erected and measures being set
ticularly difficult for poor countries. Recently, by individual countries recognizing their own
responsibilities as they see international agree?
ment being built. People seem to understand
31 Own calculations using, for example, the McKinsey
cost curve, and working with power stations of a few hun?
the arguments for action and collaboration on
dred megawatts. I am grateful to Dennis Anderson for his climate change much more readily than they
advice. do for international trade. But I do not want to
procrastination and delay under the banner

pretend that the problems and necessary actions
"more research to do" or "let's wait and see
are universally recognized and accepted. Scien?
tific agreement seems broad and deep, but Thewe former argument is always true but we hav
cannot yet say that about economic policy, theorurgent challenge of giving good advice now
about economists. This is a time for exchange
based on what we currently understand. An
of ideas and intensive discussion. Economic
the latter, in my view, is misguided?waitin
will
policy is much too important here to be left to take us into territory that we can now see
noneconomists. probably very dangerous and from which it wil
It is intensive public discussion that will,
be in
very difficult to reverse. Acting now will gi
my view, be the ultimate enforcement mecha?
us, at fairly modest cost, a cleaner world an
nism. For example, in November 2007 we saw an
environment, even if, as seems very improbable
Australian prime minister thrown out of officetheinvast majority of climate scientists have got
part because of his perceived weakness onwrong.this If we conclude that whatever the merit
issue. It is remarkable that when elections come
of the argument, it is all too difficult to make
and implement policy, then we should at lea
around, politicians recognize strong public inter?
est and demand for action. And it has become a
be clear about the great magnitude of the risk
unifying and defining issue in the structures of of
moving to concentrations of 650ppm C02e o
Europe. It has not moved at the same pace in more,
all which are the likely consequences of no,
weak, or delayed action.
countries, but we are also seeing strong changes
in perception in the key countries of the United It is hard to imagine a more important an
States, China, and India. fascinating problem for research. It will involv
Beyond discussion, there are some promis? all our skills and more, and it will require col?
ing movements in world and individual coun? laboration across disciplines. This is a time and
try policy. The UNFCCC 13th Conference of
a subject for economists to prove their worth.
the Parties, COP 13, in Bali in December Looking
2007 at the quality of this company her
was a major step forward, with all countries
in New Orleans, I am confident that they will
do so.
involved broadly (but not universally) recogniz?
ing the need for overall 50 percent cuts by 2050
and 25-40 percent cuts by rich countries by
2020 (although only the phrase "deep cuts" was REFERENCES
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American Economic Association

The Economics of Climate Change

RICHARD T. ELY LECTURE

The Economics of Climate Change

more easily controlled by policy. However,

Eventual temperature change (relative to prelnduatrial)

Figure 1. Stabilization and Eventual Change in Temperature

Table 1?Likelihood (in percentage) of Exceeding a Temperature Increase

Agency (IEA) 2007), China's energy-related

4 To avoid excessive length of discussion, we focus on

Figure 2. BAU and Stabilization Trajectories for 450-550ppm C02e

Source: Stern Review. Figure 8.4 (Stern 2007, 233).

Figure 3. Reducing Emissions Requires Action across Many Sectors

Source: Stern 2007, 196.

Figure 4. McKinsey Bottom-Up Approach to Abatement Costs

Source: Enkvist et al. 2007, 38.

It is very important to recognize reduce emissions, and thus risks. Th

10 These assessments refer to the potential shifts of

and Weitzman (2007b)?implies that theDistributional

of how society acting together should

Table 2?Sensitivity of Total Cost of Climate Change to Key Model Assumptions

Damage function Consumption elasticity of social marginal utility (17)

Note: Units are percentage losses in the BGE relativ

Role for Both Risk and Ethics

mate change, i.e., ?Qg{t)f(t) dt = ??. An example is g(t)= Vf{t).

? Clearly, both ethical values and risk play key roles.

probability distributions (particularly of climate and damages is an example of Knightian uncer?

179)?although we did not publish results.

IPCC AR4 WMtf range (66%)

Eventual temperature change (relative to ore-industrial)

Figure 5. Estimates of Climate Sensitivity from IAMs Compared to GCMs

Source: Dietz et al. 2007a.

Looking at the reasons

firms that may succeed in getting large quota

Supercritical coal (97%)

Figure 7. Cost of Electricity for Different Techn

Note: The number in brackets indicates speed of learning: 65 percent m

Source: Stern 2007, 254.

number of "less mature" technologies costs of

Figure 8. Public Energy R&D Investments as a Share of GDP

Source: Stern 2007,401.

Figure 9. Per Capita C02 Emissions (in tons)

Source: CDIAC 2007.

29 Asserting equal rights to pollute or emit seems to me

Table 3?Key Elements of a Global Deal: Targets and Trade

? Confirm Heiligendamm 50 percent cuts in world emissions by 2050 with

? Rich country reductions and trading schemes designed to be open to

? Supply side from developing countries simplifed to allow much bigger

Table 4?Key Elements of a Global Deal: Funding Issues

? Strong initiatives, with public funding, on deforestation to prepare for

? Demonstration and sharing of technologies: e.g., $5 billion per annum

procrastination and delay under the banner

Jansen, E., J. Overpeck, K. R. Briffa, J.-C. Dup

Weitzman, Martin L. 2007a. "On Modeling andL. 2007c. "Subjective Expec?

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