Tuesday, January 16, 2007

Stern explains climate change "discount rate" dilemmas on the FT

The FT interviewed last week Sir Nicholas Stern, the author of the Stern Review, which the UK Treasury issued in 2006 and which had a major impact around the world. This article is very clear and explains very clearly why his critics are wrong. Interestingly, the reason has nothing to do with economics, but rather with ethics.

These critics said the Stern Review chose a "discount rate" that was too low. The discount rate is used to translate the probable future costs and benefits of climate change into a value for today. This, they say, makes action look more urgent than it is.

In the interview with the FT, Sir Nicholas said that a higher discount rate, such as used in some other economic models, made little sense in this case because it placed too low a value on the lives of future generations.

What he said:

"We made it very clear in the review that a pure time discount rate is going to influence whether you put a lot of money into climate change or not. A pure time discount rate of 1 per cent essentially takes out, if you look forward a hundred years, two-thirds of the benefit, irrespective of the wealth of future generations. So you are telling a grandchild who is 60 years younger than you: 'You are only worth half'.

"If you want to argue for a very high pure time discount, then give me a reason. I haven't heard a good one. And this is an ethical discussion we should have."

"For me the most persuasive argument is to describe those risks [of climate change] in some detail, look at the costs in different parts of the world, and then present yourself and decision-makers with the question: 'Would you be prepared to pay this amount to take those kinds of risks away?' And you don't need to do detailed aggregation to come to grips with that -question."