Bill Totten's Weblog

Thursday, December 28, 2006

The Economics of Climate Change (first of three posts)

Stern Review: Executive Summary


The following is the first (of three) installments of the Executive Summary of the Stern Review on the Economics of Climate Change that we edited into text format from the original PDF document posted by on October 30 2006.

Although technically detailed, I decided to make it available for future reference on this site. I am posting it in three parts because of its length. I plan to post the second and third installments tomorrow and the day after.

For an informative discussion of the consequences of ignoring the urgent message of the Stern Review, please see my December 1st post, "Not in my name" (The Stern Review: The Ecologist Editors' Comment, December 2006 / January 2007) at


Stern Review on The Economics of Climate Change
Executive Summary (Part 1 of 3)

The scientific evidence is now overwhelming: climate change presents very serious global risks, and it demands an urgent global response.

This independent Review was commissioned by the Chancellor of the Exchequer, reporting to both the Chancellor and to the Prime Minister, as a contribution to assessing the evidence and building understanding of the economics of climate change.

The Review first examines the evidence on the economic impacts of climate change itself, and explores the economics of stabilising greenhouse gases in the atmosphere. The second half of the Review considers the complex policy challenges involved in managing the transition to a low-carbon economy and in ensuring that societies can adapt to the consequences of climate change that can no longer be avoided.

The Review takes an international perspective. Climate change is global in its causes and consequences, and international collective action will be critical in driving an effective, efficient and equitable response on the scale required. This response will require deeper international co-operation in many areas - most notably in creating price signals and markets for carbon, spurring technology research, development and deployment, and promoting adaptation, particularly for developing countries.

Climate change presents a unique challenge for economics: it is the greatest and widest-ranging market failure ever seen. The economic analysis must therefore be global, deal with long time horizons, have the economics of risk and uncertainty at centre stage, and examine the possibility of major, non-marginal change. To meet these requirements, the Review draws on ideas and techniques from most of the important areas of economics, including many recent advances.

<> The benefits of strong, early action on climate change outweigh the costs

The effects of our actions now on future changes in the climate have long lead times. What we do now can have only a limited effect on the climate over the next forty or fifty years. On the other hand what we do in the next ten or twenty years can have a profound effect on the climate in the second half of this century and in the next.

No one can predict the consequences of climate change with complete certainty; but we now know enough to understand the risks. Mitigation - taking strong action to reduce emissions - must be viewed as an investment, a cost incurred now and in the coming few decades to avoid the risks of very severe consequences in the future. If these investments are made wisely, the costs will be manageable, and there will be a wide range of opportunities for growth and development along the way. For this to work well, policy must promote sound market signals, overcome market failures and have equity and risk mitigation at its core. That essentially is the conceptual framework of this Review.

The Review considers the economic costs of the impacts of climate change, and the costs and benefits of action to reduce the emissions of greenhouse gases (GHGs) that cause it, in three different ways:

* Using disaggregated techniques, in other words considering the physical impacts of climate change on the economy, on human life and on the environment, and examining the resource costs of different technologies and strategies to reduce greenhouse gas emissions;

* Using economic models, including integrated assessment models that estimate the economic impacts of climate change, and macro-economic models that represent the costs and effects of the transition to low-carbon energy systems for the economy as a whole;

* Using comparisons of the current level and future trajectories of the 'social cost of carbon' (the cost of impacts associated with an additional unit of greenhouse gas emissions) with the marginal abatement cost (the costs associated with incremental reductions in units of emissions).

From all of these perspectives, the evidence gathered by the Review leads to a simple conclusion: the benefits of strong, early action considerably outweigh the costs.

The evidence shows that ignoring climate change will eventually damage economic growth. Our actions over the coming few decades could create risks of major disruption to economic and social activity, later in this century and in the next, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century. And it will be difficult or impossible to reverse these changes. Tackling climate change is the pro-growth strategy for the longer term, and it can be done in a way that does not cap the aspirations for growth of rich or poor countries. The earlier effective action is taken, the less costly it will be.

At the same time, given that climate change is happening, measures to help people adapt to it are essential. And the less mitigation we do now, the greater the difficulty of continuing to adapt in future.

The first half of the Review considers how the evidence on the economic impacts of climate change, and on the costs and benefits of action to reduce greenhouse gas emissions, relates to the conceptual framework described above.

<> The scientific evidence points to increasing risks of serious, irreversible impacts from climate change associated with business-as-usual paths for emissions.

The scientific evidence on the causes and future paths of climate change is strengthening all the time. In particular, scientists are now able to attach probabilities to the temperature outcomes and impacts on the natural environment associated with different levels of stabilisation of greenhouse gases in the atmosphere. Scientists also now understand much more about the potential for dynamic feedbacks that have, in previous times of climate change, strongly amplified the underlying physical processes.

The stocks of greenhouse gases in the atmosphere (including carbon dioxide, methane, nitrous oxides and a number of gases that arise from industrial processes) are rising, as a result of human activity. The sources are summarised in Figure 1 (explanation and URL appear at end of this post).

The current level or stock of greenhouse gases in the atmosphere is equivalent to around 430 parts per million (ppm) CO2 {1}, compared with only 280 ppm before the Industrial Revolution. These concentrations have already caused the world to warm by more than half a degree Celsius and will lead to at least a further half degree warming over the next few decades, because of the inertia in the climate system.

Even if the annual flow of emissions did not increase beyond today's rate, the stock of greenhouse gases in the atmosphere would reach double pre-industrial levels by 2050 - that is 550 ppm carbon dioxide equivalent (CO2e) - and would continue growing thereafter. But the annual flow of emissions is accelerating, as fast-growing economies invest in high-carbon infrastructure and as demand for energy and transport increases around the world. The level of 550 ppm CO2e could be reached as early as 2035. At this level there is at least a 77% chance - and perhaps up to a 99% chance, depending on the climate model used - of a global average temperature rise exceeding 2 degrees Celsius.

Under a business-as-usual scenario, the stock of greenhouse gases could more than treble by the end of the century, giving at least a fifty percent risk of exceeding five degrees Celsius global average temperature change during the following decades. This would take humans into unknown territory. An illustration of the scale of such an increase is that we are now only around five degrees Celsius warmer than in the last ice age.

Such changes would transform the physical geography of the world. A radical change in the physical geography of the world must have powerful implications for the human geography - where people live, and how they live their lives.

Figure 2 (explanation, notes and URL appear at end of this post) summarises the scientific evidence of the links between concentrations of greenhouse gases in the atmosphere, the probability of different levels of global average temperature change, and the physical impacts expected for each level. The risks of serious, irreversible impacts of climate change increase strongly as concentrations of greenhouse gases in the atmosphere rise.

<> Climate change threatens the basic elements of life for people around the world - access to water, food production, health, and use of land and the environment.

Estimating the economic costs of climate change is challenging, but there is a range of methods or approaches that enable us to assess the likely magnitude of the risks and compare them with the costs. This Review considers three of these approaches.

This Review has first considered in detail the physical impacts on economic activity, on human life and on the environment.

On current trends, average global temperatures will rise by two to three degrees Celsius within the next fifty years or so. {5} The Earth will be committed to several degrees more warming if emissions continue to grow.

Warming will have many severe impacts, often mediated through water:

* Melting glaciers will initially increase flood risk and then strongly reduce water supplies, eventually threatening one-sixth of the world's population, predominantly in the Indian sub-continent, parts of China, and the Andes in South America.

* Declining crop yields, especially in Africa, could leave hundreds of millions without the ability to produce or purchase sufficient food. At mid to high latitudes, crop yields may increase for moderate temperature rises (two to three degrees Celsius), but then decline with greater amounts of warming. At four degrees Celsius above, global food production is likely to be seriously affected.

* In higher latitudes, cold-related deaths will decrease. But climate change will increase worldwide deaths from malnutrition and heat stress. Vector-borne diseases such as malaria and dengue fever could become more widespread if effective control measures are not in place.

* Rising sea levels will result in tens to hundreds of millions more people flooded each year with warming of three or four degrees Celsius. There will be serious risks and increasing pressures for coastal protection in South East Asia (Bangladesh and Vietnam), small islands in the Caribbean and the Pacific, and large coastal cities, such as Tokyo, New York, Cairo and London. According to one estimate, by the middle of the century, 200 million people may become permanently displaced due to rising sea levels, heavier floods, and more intense droughts.

* Ecosystems will be particularly vulnerable to climate change, with around fifteen to forty percent of species potentially facing extinction after only two degrees Celsius of warming. And ocean acidification, a direct result of rising carbon dioxide levels, will have major effects on marine ecosystems, with possible adverse consequences on fish stocks.

<> The damages from climate change will accelerate as the world gets warmer.

Higher temperatures will increase the chance of triggering abrupt and large-scale changes.

* Warming may induce sudden shifts in regional weather patterns such as the monsoon rains in South Asia or the El Nino phenomenon - changes that would have severe consequences for water availability and flooding in tropical regions and threaten the livelihoods of millions of people.

* A number of studies suggest that the Amazon rainforest could be vulnerable to climate change, with models projecting significant drying in this region. One model, for example, finds that the Amazon rainforest could be significantly, and possibly irrevocably, damaged by a warming of two to three degrees Celsius.

* The melting or collapse of ice sheets would eventually threaten land which today is home to one in every twenty people.

While there is much to learn about these risks, the temperatures that may result from unabated climate change will take the world outside the range of human experience. This points to the possibility of very damaging consequences.

<> The impacts of climate change are not evenly distributed - the poorest countries and people will suffer earliest and most. And if and when the damages appear it will be too late to reverse the process. Thus we are forced to look a long way ahead.

Climate change is a grave threat to the developing world and a major obstacle to continued poverty reduction across its many dimensions. First, developing regions are at a geographic disadvantage: they are already warmer, on average, than developed regions, and they also suffer from high rainfall variability. As a result, further warming will bring poor countries high costs and few benefits. Second, developing countries - in particular the poorest - are heavily dependent on agriculture, the most climate-sensitive of all economic sectors, and suffer from inadequate health provision and low-quality public services. Third, their low incomes and vulnerabilities make adaptation to climate change particularly difficult.

Because of these vulnerabilities, climate change is likely to reduce further already low incomes and increase illness and death rates in developing countries. Falling farm incomes will increase poverty and reduce the ability of households to invest in a better future, forcing them to use up meagre savings just to survive. At a national level, climate change will cut revenues and raise spending needs, worsening public finances.

Many developing countries are already struggling to cope with their current climate. Climatic shocks cause setbacks to economic and social development in developing countries today even with temperature increases of less than one degree Celsius. The impacts of unabated climate change, - that is, increases of three or four degrees Celsius and upwards - will be to increase the risks and costs of these events very powerfully.

Impacts on this scale could spill over national borders, exacerbating the damage further. Rising sea levels and other climate-driven changes could drive millions of people to migrate: more than a fifth of Bangladesh could be under water with a one metre rise in sea levels, which is a possibility by the end of the century. Climate-related shocks have sparked violent conflict in the past, and conflict is a serious risk in areas such as West Africa, the Nile Basin and Central Asia.

<> Climate change may initially have small positive effects for a few developed countries, but is likely to be very damaging for the much higher temperature increases expected by mid- to late-century under business-as-usual scenarios.

In higher latitude regions, such as Canada, Russia and Scandinavia, climate change may lead to net benefits for temperature increases of two or three degrees Celsius, through higher agricultural yields, lower winter mortality, lower heating requirements, and a possible boost to tourism. But these regions will also experience the most rapid rates of warming, damaging infrastructure, human health, local livelihoods and biodiversity. Developed countries in lower latitudes will be more vulnerable - for example, water availability and crop yields in southern Europe are expected to decline by twenty percent with a two degrees Celsius increase in global temperatures. Regions where water is already scarce will face serious difficulties and growing costs.

The increased costs of damage from extreme weather (storms, hurricanes, typhoons, floods, droughts, and heat waves) counteract some early benefits of climate change and will increase rapidly at higher temperatures. Based on simple extrapolations, costs of extreme weather alone could reach 0.5% to one percent of world GDP per annum by the middle of the century, and will keep rising if the world continues to warm.

* A five or ten percent increase in hurricane wind speed, linked to rising sea temperatures, is predicted approximately to double annual damage costs, in the USA.

* In the UK, annual flood losses alone could increase from 0.1% of GDP today to 0.2 to 0.4% of GDP once the increase in global average temperatures reaches three or four degrees Celsius.

* Heat waves like that experienced in 2003 in Europe, when 35,000 people died and agricultural losses reached $15 billion, will be commonplace by the middle of the century.

At higher temperatures, developed economies face a growing risk of large-scale shocks - for example, the rising costs of extreme weather events could affect global financial markets through higher and more volatile costs of insurance.

<> Integrated assessment models provide a tool for estimating the total impact on the economy; our estimates suggest that this is likely to be higher than previously suggested.

The second approach to examining the risks and costs of climate change adopted in the Review is to use integrated assessment models to provide aggregate monetary estimates.

Formal modelling of the overall impact of climate change in monetary terms is a formidable challenge, and the limitations to modelling the world over two centuries or more demand great caution in interpreting results. However, as we have explained, the lags from action to effect are very long and the quantitative analysis needed to inform action will depend on such long-range modelling exercises. The monetary impacts of climate change are now expected to be more serious than many earlier studies suggested, not least because those studies tended to exclude some of the most uncertain but potentially most damaging impacts. Thanks to recent advances in the science, it is now possible to examine these risks more directly, using probabilities.

Most formal modelling in the past has used as a starting point a scenario of two to three degrees Celsius warming. In this temperature range, the cost of climate change could be equivalent to a permanent loss of up to three percent in global world output compared with what could have been achieved in a world without climate change. Developing countries will suffer even higher costs.

However, those earlier models were too optimistic about warming: more recent evidence indicates that temperature changes resulting from business-as-usual trends in emissions may exceed two to three degrees Celsius by the end of this century. This increases the likelihood of a wider range of impacts than previously considered. Many of these impacts, such as abrupt and large-scale climate change, are more difficult to quantify. With five to six degrees Celsius warming - which is a real possibility for the next century - existing models that include the risk of abrupt and large-scale climate change estimate an average five to ten percent loss in global GDP, with poor countries suffering costs in excess of ten percent of GDP. Further, there is some evidence of small but significant risks of temperature rises even above this range. Such temperature increases would take us into territory unknown to human experience and involve radical changes in the world around us.

With such possibilities on the horizon, it was clear that the modelling framework used by this Review had to be built around the economics of risk. Averaging across possibilities conceals risks. The risks of outcomes much worse than expected are very real and they could be catastrophic. Policy on climate change is in large measure about reducing these risks. They cannot be fully eliminated, but they can be substantially reduced. Such a modelling framework has to take into account ethical judgements on the distribution of income and on how to treat future generations.

The analysis should not focus only on narrow measures of income like GDP. The consequences of climate change for health and for the environment are likely to be severe. Overall comparison of different strategies will include evaluation of these consequences too. Again, difficult conceptual, ethical and measurement issues are involved, and the results have to be treated with due circumspection.

The Review uses the results from one particular model, PAGE2002, to illustrate how the estimates derived from these integrated assessment models change in response to updated scientific evidence on the probabilities attached to degrees of temperature rise. The choice of model was guided by our desire to analyse risks explicitly - this is one of the very few models that would allow that exercise. Further, its underlying assumptions span the range of previous studies. We have used this model with one set of data consistent with the climate predictions of the 2001 report of the Intergovernmental Panel on Climate Change, and with one set that includes a small increase in the amplifying feedbacks in the climate system. This increase illustrates one area of the increased risks of climate change that have appeared in the peer-reviewed scientific literature published since 2001.

We have also considered how the application of appropriate discount rates, assumptions about the equity weighting attached to the valuation of impacts in poor countries, and estimates of the impacts on mortality and the environment would increase the estimated economic costs of climate change.

Using this model, and including those elements of the analysis that can be incorporated at the moment, we estimate the total cost over the next two centuries of climate change associated under business-as-usual emissions involves impacts and risks that are equivalent to an average reduction in global per-capita consumption of at least five percent, now and forever. While this cost estimate is already strikingly high, it also leaves out much that is important.

The cost of business-as-usual would increase still further, were the model systematically to take account of three important factors:

* First, including direct impacts on the environment and human health (sometimes called 'non-market' impacts) increases our estimate of the total cost of climate change on this path from five percent to eleven percent of global per-capita consumption. There are difficult analytical and ethical issues of measurement here. The methods used in this model are fairly conservative in the value they assign to these impacts.

* Second, some recent scientific evidence indicates that the climate system may be more responsive to greenhouse-gas emissions than previously thought, for example because of the existence of amplifying feedbacks such as the release of methane and weakening of carbon sinks. Our estimates, based on modelling a limited increase in this responsiveness, indicate that the potential scale of the climate response could increase the cost of climate change on the business-as-usual path from five percent to seven percent of global consumption, or from eleven percent to fourteen percent if the non-market impacts described above are included.

* Third, a disproportionate share of the climate-change burden falls on poor regions of the world. If we weight this unequal burden appropriately, the estimated global cost of climate change at five to six degrees Celsius warming could be more than one-quarter higher than without such weights.

Putting these additional factors together would increase the total cost of business-as-usual climate change to the equivalent of around a twenty percent reduction in consumption per head, now and into the future.

In summary, analyses that take into account the full ranges of both impacts and possible outcomes - that is, that employ the basic economics of risk - suggest that business-as-usual climate change will reduce welfare by an amount equivalent to a reduction in consumption per head of between 5 and twenty percent. Taking account of the increasing scientific evidence of greater risks, of aversion to the possibilities of catastrophe, and of a broader approach to the consequences than implied by narrow output measures, the appropriate estimate is likely to be in the upper part of this range.

Economic forecasting over just a few years is a difficult and imprecise task. The analysis of climate change requires, by its nature, that we look out over fifty, one hundred, two hundred years and more. Any such modelling requires caution and humility, and the results are specific to the model and its assumptions. They should not be endowed with a precision and certainty that is simply impossible to achieve. Further, some of the big uncertainties in the science and the economics concern the areas we know least about (for example, the impacts of very high temperatures), and for good reason - this is unknown territory. The main message from these models is that when we try to take due account of the upside risks and uncertainties, the probability-weighted costs look very large. Much (but not all) of the risk can be reduced through a strong mitigation policy, and we argue that this can be achieved at a far lower cost than those calculated for the impacts. In this sense, mitigation is a highly productive investment.


Figures Referenced Above

For actual figures, see

Figure 1: Greenhouse-gas emissions in 2000, by source.

Total emissions in 2000: 42 billion tonnes of carbon dioxide equivalent (42 GtCO2e).

Energy Emissions: Power (24%); Industry (14%); Transport (14%); Buildings (8%); Other Energy Related (5%). Energy emissions are mostly CO2 (some non-CO2 in industry and other energy related).

Non-Energy Emissions: Land-Use (18%); Agriculture (14%); Waste (3%). Non-energy emissions are CO2 (land use) and non-CO2 (agriculture and waste).

Source: Prepared by Stern Review, from data drawn from World Resources Institute Climate Analysis Indicators Tool (CAIT) on-line database version 3.0.

Figure 2: Stabilisation levels and probability ranges for temperature increases

This figure illustrates the types of impacts that could be experienced as the world comes into equilibrium with more greenhouse gases. The top panel shows the range of temperatures projected at stabilisation levels between 400 ppm and 750 ppm CO2e at equilibrium. The solid horizontal lines indicate the 5% to 95% range based on climate sensitivity estimates from the IPCC 2001 {2} and a recent Hadley Centre ensemble study {3}. The vertical line indicates the mean of the fiftieth percentile point. The dashed lines show the 5% to 95% range based on eleven recent studies {4}. The bottom panel illustrates the range of impacts expected at different levels of warming. The relationship between global average temperature changes and regional climate changes is very uncertain, especially with regard to changes in precipitation ... This figure shows potential changes based on current scientific literature.


{1} Referred to hereafter as CO2 equivalent, CO2e.

{2} Wigley, T M L and S C B Raper (2001): 'Interpretation of high projections for global-mean warming', 451-454 based on Intergovernmental Panel on Climate Change (2001): 'Climate change 2001: the scientific Contribution of Working Group I to the Third Assessment Report of the Intergovernmental Panel on Climate [Houghton J T, Ding Y, Griggs D J, et al (eds)], Cambridge: Cambridge University Press.

{3} Murphy, J M, D M H Sexton, D N Barnett et al (2004): 'Quantification of modelling uncertainties in a ensemble of climate change simulations', Nature 430: 768-772

{4} Meinshausen, M (2006): 'What does a two degrees Celsius target mean for greenhouse gas concentrations? A brief analysis on multi-gas emission pathways and several climate sensitivity uncertainty estimates', Avoiding dangerous change, in H J Schellnhuber et al (eds), Cambridge: Cambridge University Press, pages 265-280.

{5} All changes in global mean temperature are expressed relative to pre-industrial levels (1750-1850).

Bill Totten


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