"On Climate Change and Good Sense"

Below is a comment, On Climate Change and Good Sense,” from Samuel Brittan of the Financial Times on the UK’s Stern Report, which estimated the economic costs of global warming. The report has been criticized for using too low a discount rate, which would have the effect of making the financial impact look larger. Brittan discusses the rationale for the discount rate assumptions and the impact of increasing the rate, and still finds there to be good reason to combat climate change.

Years ago I used to see a South African relation who had married what I can only call a financial trophy husband. Whenever this unfortunate man dared to express an opinion he would be silenced by his wife, who would say: “Barney, don’t talk about things you don’t know.” It is to avoid Barney’s fate that I have written so little about global warming.

All I would say about the main argument is that the attempt to ignore or silence dissenters is more reminiscent of the Catholic Church’s crusade against the Albigensian heresy in the Middle Ages than of the free inquiry of the Enlightenment.

Scientific arguments are not decided by majority votes or global committees. For instance, the December issue of World Economics carried a considered article, “The Stern Review: A Dual Critique”, half of which was written by physical scientists and half by economists. The authors deserve a response.

The Stern Review suggests on the first page of the summary that business as usual – that is, making no special effort to curb the emission of greenhouse gases – would “be equivalent to losing at least 5 per cent of global gross domestic product each year now and for ever”. There are many warnings that the estimate could be larger, rising to 20 per cent or more. It considers that policies to stabilise emissions at a little above present levels would cost about 1 per cent of world GDP by 2050. On this basis it concludes that it is possible to “decarbonise” countries while maintaining economic growth.

There is, however, one aspect of Sir Nicholas Stern’s report that one does not have to be a climatologist to discuss, namely his refusal to discount events in the far future. This was a feature first pointed out by Max Wilkinson in the Financial Times on November 3, just after the report appeared.

In chapter two of the report, a parade of distinguished names in philosophy and economics is invoked to pour scorn on any idea of preferring the present to the remote future. The fact that human beings attach less weight to future joys and sorrows than present ones is more impressive than the reasons suggested for it, which include gibes such as “weakness of the imagination”, “defective telescoping faculty” and “a polite expression for rapacity and the conquest of reason by passion”.

These quotations demonstrate mainly the supposed superiority of the mandarin analyst. Indeed, Sir Nicholas says that “those who would put little weight on the future (regardless of how living standards develop) would similarly show little concern for the problem of climate change”. The implication is that such people are beyond the pale of rational discourse.

In its detailed calculations, the Stern Review uses a pure rate of time preference (the value of jam today compared with jam tomorrow), not literally zero but 0.1 per cent. This is ostensibly to insure against the possibility of the human race’s disappearing. There is, however, an interesting admission by Sir Nicholas in the technical annex to his postscript that using a pure time discount rate of 1.5 per cent would reduce the loss from business as usual in the basic case from 5 per cent to 1.4 per cent of world GDP.

This does not go far enough. The least bad guide to average pure time preference is probably world long-term real interest rates, which now average 2 per cent for the main industrial countries. Even this is unusually low and reflects an incipient world savings surplus arising in Asia and the oil producing countries. Ten years ago, world real interest rates were nearly 4 per cent – more typical of modern experience.

There is, however, another way Sir Nicholas artificially reduces the future cost of global warning. For, in his actual arithmetic, he uses an effective discount rate of 2.1 per cent. The extra 2 percentage points comes not from time preference – heaven forbid – but from the assumption that future generations will be much richer than we are and therefore better able to countenance some income loss from global warning. But I do not need to invoke fashionable “happiness” studies to be extremely cautious about jumping from projected GDP growth to assertions about the welfare of future generations. I would advocate a realistic time preference estimate and leave aside presumptions about the welfare of future generations.

We are then left with an effective discount rate of, say, 3½ per cent for the base case. This still leaves global warming as a problem, if not quite on the scale Sir Nicholas envisages. The report’s remedies are: establishing a realistic (that is higher) international carbon price; an end to gas guzzling; research on low-carbon technologies; improving information and regulation; action to reduce deforestation; and help to poorer countries to adapt to climate change. Most of these policies are desirable on old-fashioned anti-pollution and environmental grounds. Above all, they might reduce energy dependence on the Middle East and other unstable regions, which is the problem I find most worrying.

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