The Stern Gang rides again

Eli opened up his July 13 issue of Science Magazine and read articles by William Nordhaus and Nicholas Stern on the Stern Report. There is not much new to report to those who have been following the argument. Nordhaus is still flogging his ramp

What is the logic of the ramp? In a world where capital is productive and damages are far in the future (see chart above), the highest-return investments today are primarily in tangible, technological, and human capital. In the coming decades, damages are predicted to rise relative to output. As that occurs, it becomes efficient to shift investments toward more intensive emissions reductions and the accompanying higher carbon taxes. The exact timing of emissions reductions depends on details of costs, damages, learning, and the extent to which climate change and damages are nonlinear and irreversible.

and criticizing Stern's discounting. Nordhaus assumes that most of the damages from climate change will occur after 2200, so costs in the next 200 years will be low. Under this assumption if one uses higher discount rates more typical of those in economic models

The optimal carbon tax and the social cost of carbon decline by a factor of ~10 relative to these consistent with the Stern Review's assumptions, and the efficient trajectory looks like the policy ramp discussed above. In other words, the Stern Review's alarming findings about damages, as well as its economic rationale, rest on its model parameterization--a low time discount rate and low inequality aversion--that leads to savings rates and real returns that differ greatly from actual market data. If we correct these parameterizations, we get a carbon tax and emissions reductions that look like standard economic models.

The Stern Review's unambiguous conclusions about the need for urgent and immediate action will not survive the substitution of assumptions that are consistent with today's marketplace real interest rates and savings rates. So the central questions about global-warming policy--how much, how fast, and how costly--remain open.

The last point, that market discount rates are appropriate is one that is contested by Nicholas Stern.

Many of the comments on the review have suggested that the ethical side of the modeling should be consistent with observable market behavior. As discussed by Hepburn, there are many reasons for thinking that market rates and other approaches that illustrate observable market behavior cannot be seen as reflections of an ethical response to the issues at hand. There is no real economic market that reveals our ethical decisions on how we should act together on environmental issues in the very long term.

Most long-term capital markets are very thin and imperfect. Choices that reflect current individual personal allocations of resource may be different from collective values and from what individuals may prefer in their capacity as citizens. Individuals will have a different attitude to risk because they have a higher probability of demise in that year than society. Those who do not feature in the market place (future generations) have no say in the calculus, and those who feature in the market less prominently (the young and the poor) have less influence on the behaviors that are being observed.

Another recurring point is that

The ethical approach in Nordhaus' modeling helps drive the initial low level of action and the steepness of his policy ramp. As future generations have a lower weight they are expected to shoulder the burden of greater mitigation costs. This could be a source of dynamic inconsistency, because future generations will be faced with the same challenge and, if they take the same approach, will also seek to minimize short-term costs but expect greater reductions in the future as they place a larger weight on consumption now over the effects on future generations (thus perpetuating the delay for significant reductions).

Something that Mark Thoma comments on when pointing out that Robert Samuelson plays Intellectual Three Card Monte with Lubos Motl .

In my view, Robert Samuelson is a bad person: when a carbon tax was on the agenda and we had a real window of opportunity, he fought it; now when the only things on the agenda are preference-shaping tools that I regard as very weak compared to a carbon tax, he's against them as well on the grounds that "hippie... Prius politics is... showing off" and that a carbon tax would be good. A little intellectual three-card-monte here, doncha think?

A principal values of the Nordhaus and Stern articles are links to papers and book chapters available on the net for those seeking more detail.

1. W. D. Nordhaus, "The Challenge of Global Warming: Economic Models and Environmental Policy" (Yale Univ., New Haven, CT, 2007); available at http://nordhaus.econ.yale.edu/recent_stuff.html.
2. W. D. Nordhaus, J. Econ. Lit., in press; available at http://nordhaus.econ.yale.edu/recent_stuff.html.
3. K. J. Arrow et al. Climate Change 1995--Economic and Social Dimensions of Climate Change, http://nordhaus.econ.yale.edu/stern_050307.pdf
4. T. Sterner, U. M. Persson, "An even sterner review: Introducing relative prices into the discounting debate," Working draft, May 2007; www.hgu.gu.se/files/nationalekonomi/personal/thomas%20sterner/b88.pdf
5. C. Hepburn, "The economics and ethics of Stern discounting," presentation at the workshop the Economics of Climate Change, 9 March 2007, University of Birmingham, Birmingham, UK; www.economics.bham.ac.uk/maddison/Cameron%20Hepburn%20Presentation.pdf
6. N. Stern, "Value judgments, welfare weights and discounting," Paper B of "After the Stern Review: Reflections and responses," 12 February 2007, Working draft of paper published on Stern Review Web site; www.sternreview.org.uk
7. N. Stern, "The case for action to reduce the risks of climate change," Paper A of "After the Stern Review: Reflections and responses," working draft of paper published on Stern Review Web site, 12 February 2007; www.sternreview.org.uk.