Tuesday, December 1, 2009

The Stern Review on the Economics of Climate Change

I have some strong reservations about the Stern Review primarily because the economic assumptions within it are not realistic. You can read the whole report here,

1) Economic projections that go out more than one generation are little more speculation. If someone had told us in 1979 that we would see low inflation, long term strong global growth, the decline of Japan or the rise of China, I suspect no one would have taken it seriously. I have this great Omni book from 1979 that predicts where we will be in the future. Suffice it to say they got most of it wrong for 2009.

To think that we can know what will be the driving factor in the global economy in 2050 or later is hubris. We can make some broad assumptions based on past experience: more free trade, more and consistent economic growth, lower use of energy per dollar of global GDP produced, and fewer poor people. How we will achieve these things is not something we can see.

The Stern Review looks out not only over a generation, but out to 2200. Within the review's projections, there are few economic impacts till 2070 or 2080. That is two generations out.

The Stern Review projections are based on one major assumption - nothing will change from the current world. No new technology, no change in consumption rates, no change in governance, no change in anything from today. The report feels like what 2005 would look like if we had a much warmer planet and nothing else is changed. This is simply unrealistic.

2) The discount rate Stern uses is remarkably low. Discount rate is how much you reduce the value of something in the future to measure its value today. Stern uses a rate of 1.4%, in no other economic projections I have seen anyone use a number that low. A low discount rate means you are assuming a high degree of risk. Stern also assesses a risk premium in his review. You can not both have a discount rate and a risk premium, it is double counting. He is effectively assuming a discount rate over a generation of 0.8%.

A discount rate should reflect something roughly comparably to what the expected average rate of return of an investment would be over the same term. Looking at long term bonds, something in the order of 3% is a realistic conservative discount rate or risk premium.

3) The Stern Review assumes the cost of mitigation is based on the current day costs of actions to be taken. This is not realistic. Mitigation becomes cheaper as technologies change. A simple example is the LED light.

A few years ago there were very few of them and they were very expensive for lighting. Now I have seen LED lightbulbs for about $10 a piece. I assume that in a couple of years LEDs will displace all other lighting. This will dramatically reduce electrical usage. We could not have predicted this was coming as a specific change, but we can assume there will be other reductions in mitigation costs.

The cost of ending oil use will be nothing, actually it will be an economic benefit to society as we will be replacing oil with a cheaper and cleaner fuel.

Spending money now to have an ineffective impact on CO2 levels makes no sense. We need to wait till have the tools that can allow us to reduce CO2 levels at no cost to the economy. This is within our reach, within a generation we will have the tools to make this happen and not bankrupt us.

Stern also assumes that if there is no mitigation action taken now, none will be taken in the next 100 years. The Stern review is missing any model that assumes we take action in 10 to 20 years with tools that not only do not cost us anything, but give us positive economic impacts.

4) Stern does not include any useful measure of the impact of improving technology on climate change. I think it is realistic to assume that fossil fuels will not be a major part of the energy mix in a generation. This is not because we will run out, it is because it will be cheaper to obtain energy from other sources through technological changes.

We can look back at the last 150 years and see multiple energy crisis's that were solved because we moved from a scarce and more expensive fuel to a cheaper and more plentiful fuel. It is reasonable to assume this pattern will continue into the future because people will be able to make money from new and cheaper energy. Any company that is not looking at how to make its energy use lower and cheaper will be out of business quickly.

We do not know what will be driving the economy in 30 years, but it is safe to assume that there will be changes in technology that will create new jobs that no one has ever thought of and done with little or no energy. Who would have thought people in China would have jobs playing online video games to make advancing in levels easier for people in the first world? These "Gold Farmers" in China earn a better income more than 60% of the population.

The Stern Review is alarmist and puts forward an apocalyptic view of the future. The IPCC report is the bulk of the New Testament of Climate change. The Stern Review is Revalations, an odd depature from the rest of the narrative that only serves to get people caught up in worry. I view Bjorn Lombrog as a climate change Gnostic if I were to continue the analogy.

All in all the Stern Review has been a huge red herring in the climate change debate and has dramatically harmed work towards solutions to climate change. People need to forget it and get on with rational debate and action on climate change.

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