Nordhaus review of Stern on global warming

by on November 24, 2006 at 5:31 am in Economics | Permalink

Here is Bill Nordhaus’s critique of the Stern report.  Nordhaus argues that Stern’s "new" results boil down to the choice of a lower discount rate.

I agree with Stern that the discount rate should be zero or near-zero for resources which will not be reinvested but rather represent alternative consumption streams across the generations.  If we are doing normative analysis, however, and considering alternatives to controlling global warming, a’ la Copenhagen Consensus, we are by definition considering other investments.  In that case the correct rate of discount is given by opportunity costs, which might be quite high, provided the alternative investments will in fact be undertaken.  (On this topic, there are a few really good comments here.)

Having pondered the report a bit more, my main question is what it would cost for China and India to cut back on carbon emissions, all relevant institutional changes included in the calculations.  In other words, that figure should count costs of persuasion, enforcement, and implementation, not just the cost of one technology rather than another in the abstract.  We do not have a good sense of these costs, and given how many basic tasks these economies fail at, I can imagine the cynic citing the figure of infinity.  (To consider one analogy, what is "the cost" of getting avian flu out of China?)  Furthermore China in particular has a high rate of savings, and both economies have high rates of return on capital.  Current compliance costs should thus be compounded, when considering their future importance, at rates considerably higher than zero. 

9 comments

sa November 24, 2006 at 8:46 am

very good point……….

Jane Galt November 24, 2006 at 9:25 am

It’s hard not to agree that the discount rate should be zero or non-zero, as much as our politicians might like political forecasting to involve imaginary numbers . . .

But doesn’t a zero discount rate imply that even something that imposes trivial costs on each future generation should be avoided at catastrophic cost to us?

Barkley Rosser November 24, 2006 at 11:50 am

BTW, there are some cost of global warming numbers in
the Stern Report that seem excessive. One that has
been pointed out to me is that tourism revenues in the
Mediterranean would be down 30%. This seems a bit much.

Nathan November 24, 2006 at 3:34 pm

Maybe I’m reading it wrong because I don’t understand the economics entirely, but Nordhaus seems to be say that it’s not just that Stern chose a near-zero discount rate, but also that Stern chose a utility curvature that is inconsistent with the report’s discount rate. When Nordhaus plugged the Stern Report’s 0.1% discount rate into his DICE-2006 model with a calibrated utility curvature the model called for a carbon tax of only $19.55, as opposed to $159 in a run of DICE-2006 with the utility curvature from the Stern Report.

Maybe it’s because I don’t entirely understand what a utility curvature is, or what it means to calibrate it, but it seems to me like Nordhaus has more than just a beef with the discount rate. Can anyone explain this, though?

bhauth November 24, 2006 at 5:44 pm

Discount rate for, say, strip mining copper ore, should be future economic growth over (future growth of value of location – future value of location after mining)

This much is obvious. But we don’t know what the future economic growth or future values will be. That’s all it takes to get economists throwing darts to pick 1%, 2.5%, and so forth. The constructive thing to go is simply to do a best guess of ranges of these values and then find an optimal solution based on that.

Straightforward enough, yes?

K. Williams November 24, 2006 at 8:43 pm

As far as I can tell, Nordhaus is simply wrong when he says that Stern uses a 0.1 discount rate. It is true that Stern suggests that a 0.1 discount rate is appropriate when considering simply the issue of intertemporal utility comparisons (in other words, from a welfare point of view, we should not value our own welfare more highly than that of future generations). But he is explicit about the fact that we need to adjust for the time value of money, and the fact that future generations are likely to be significantly wealthier than we are. Although he curiously doesn’t state explicitly anywhere in the report exactly what the discount rate is, the technical appendix to the discussion of discounting suggests that he’s using a discount rate of around 3%, which actually seems quite reasonable.

As far as I can tell, this means that much of Nordhaus’ critique is based on a complete misreading of Stern’s math.

ChrisA November 25, 2006 at 8:11 am

I am concerned about the practicality of the Stern proposals. One of the downsides of implementing a carbon pricing regime is that the benefits are shared by all, but the disbenefits are disproportionally shared by poor people as they are the ones whose lives will be most improved by faster economic growth. This is a perfect recipe for conflict; wars and such like can cost a lot more than 1% of growth. Likely, because of this conflict of interest it will be very hard to persuade poor countries to adapt the proposals, they will be natural sceptics. Will the west be prepared to invade India and China to get them to see it our way? I don’t think so. So the only answer can be technology. However government directed technology programmes have a poor record.

Perhaps an effective method to develop the needed new technology would be for the rich countries to club together and offer a prize of, say, $100bn, for a technology answer that solves the problem (either low cost clean energy or some way to remove CO2 from the atmospher). The prize would be payable to the inventors once they had, say, through commercial application reduced CO2 in the atmosphere by a certain percentage. In order to deal with the future discount problem the prize is created now and invested so that it becomes more valuable over time. In further twist, to deal with the sceptics, it would only be payable if anthropegenic global warming thesis could proved to be correct, otherwise it reverts to the donors.

bee November 25, 2006 at 2:11 pm

Barkley-

I am aware that Stern used 0.1 at the discount rate (I said zero for convenience). The choice for all practical purposes is the same (Yes, I know that actually using zero would not play well with the math).

Again the logical problem is that it creates a world of near certainty across time. This is absurd. Given that the dynamic of a discount rate is exponential yet the thinking he is employing is linear we have the problem that Nordhaus reveals with the DICE model.

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